Long‑Term Spending Projections in Israel

1. Context, modelling approach and key results

Abstract

This chapter outlines the framework, methods, and key findings of Israel’s long-term expenditure projections up to 2065. It first discusses the rationale for strengthening long-term fiscal analysis and the key demographic and structural pressures shaping future spending in Israel. It then outlines the macroeconomic and spending projection methodology. The chapter presents baseline results and alternative scenarios that reflect different demographic and policy assumptions, illustrating their implications for public spending and key fiscal aggregates. Together, these projections provide a forward-looking view of Israel’s fiscal sustainability under current policies and possible reform paths.

1.1. Israel’s fiscal conditions and OECD approaches to long-term sustainability analysis

This section provides the context and rationale for strengthening long-term expenditure projections in Israel. It outlines the key challenges that are expected to put pressures on public expenditures in Israel and how these long-term pressures are currently informing the fiscal framework. It then briefly presents trends and selected practices for long-term fiscal sustainability analysis in OECD countries.

1.1.1. Key trends impacting public expenditures in Israel

Israel’s high GDP growth since the early 2000s, led by growth in employment, has enabled improving the sustainability of government finance and decreasing the debt-to-GDP ratio (Figure 1.1). These improvements in fiscal conditions have helped the Israeli economy and public finance remain resilient to the economic shocks caused by COVID-19 and the war. Nonetheless, overall employment growth has been on a slow but constant downward trend, while several long-term challenges put past achievements at risk (OECD, 2023[1]). Some of these challenges are common to all OECD countries, such as population ageing and the normalisation of interest rates. Others are Israeli-specific, such as the rapid increase of population groups with weak labour market attachment and elevated geopolitical risks.

Figure 1.1. Recent shocks have reversed debt reduction

General government gross debt (%)

Note: General government debt data for 2024 refers to projections.

Source: OECD National Accounts database and OECD Economic Outlook.

The projected increase in population groups with weak labour market attachment poses a significant challenge to employment, GDP and government revenue growth

The combined share of Haredim and Arab-Israelis within the working-age population is projected to increase significantly, rising from approximately 30% today to around 46% by 2065 (Figure 1.2, Panel A). Both groups exhibit relatively weak labour market attachment and low productivity. Labour force participation remains markedly lower among Haredi men and Arab women compared to the broader population, and substantial wage disparities persist between these groups and non-Haredi Jewish workers (Panel B). These disparities are mirrored in skill levels: according to the OECD Programme for the International Assessment of Adult Competencies, the average score of Arab participants is 45–60 points lower – a full standard deviation – than that of non-Haredi Jews and others (NHJO), while Haredi participants score roughly 10 points (0.2 standard deviations) below the NHJO average (Bank of Israel, 2024[2]). Nevertheless, policy changes over the last years have mostly reinforced Haredi men’s disincentives to work, accumulate relevant skills and fully integrate the labour market. There has been a substantial rise in budgetary support for yeshivas (religious seminars), whose students stay outside the labour force and are exempt from military service.

Scenario analyses conducted by the Ministry of Finance suggest that, absent significant improvements in employment rates and skill levels among these groups, demographic shifts will weigh heavily on potential GDP growth and strain public finances (Geva, 2015[3]). The Bank of Israel has calculated that if the participation of the Haredi population remains at its current levels, income taxes would have to rise by 16% to maintain the current revenues-to-GDP levels (Bank of Israel, 2019[4]) .

Figure 1.2. The share of population groups with weak labour market attachment is projected to increase

Panel A: Share of population groups in prime age (25-64)

 

Panel B: Contributions to labour income gap, relative to non-Haredi Jewish men, %, 2022

Note: B. Data for hourly wage refer to 2019. Contributions are illustrative and only concern the direct contribution of each dimension without considering interaction effects between dimensions. The size of each contribution is proportional to the gap in this dimension relative to all other dimensions for the same demographic group.

Source: A: OECD elaborations based on customised CBS 2017 population projections and the 2023 OECD economic survey. B: Israel Central Bureau of Statistics and OECD calculations.

Population ageing would likely have a negative effect on employment and put pressure on the health and social protection systems

Israel will not escape the effects of an ageing population: it will be less pronounced than in most other OECD countries, but the elderly dependency rate1 has been increasing and is set to continue rising in the coming years (Figure 1.3). This is mainly because people are, on average, living longer and are in better health, which is a positive phenomenon. Life expectancy at 65 is expected to increase by about 4 years on average between 2025 and 2065. Nonetheless, population ageing could negatively affect income per capita, labour supply and fiscal sustainability (André, Gal and Schief, 2024[5]). This is for four main reasons: (1) as people get older, they are less likely to work, and if they do work, it is generally for fewer hours (Panel B); (2) hourly earnings tend to decrease as people get older, which suggests that their productivity declines, even though studies on this subject provide ambiguous results and the declining wages for older workers could be driven by other factors such as prejudice against older workers or older workers stepping out of higher-paying jobs (New Zealand’s Treasury, 2021[6]); (3) as more of the population moves into retirement, the saving rates could decline, and savings might be shifted towards lower-risk investments; and (4) population ageing is likely to cause shifts in demand and increase public (and private) spending on pensions, health care and long-term care (Rawdanowicz et al., 2021[7]). In 2023, spending on health and old age already accounted for 26% of government expenditure in Israel.

Figure 1.3. The Israeli population is projected to age, and older individuals work less

Panel A: Share of the population aged 65+ of the total population

Context, modelling approach and key results: Long-Term Spending Projections in Israel

Panel B: Employment and usual hours worked, by age, 2023

Source: OECD elaborations based on customised CBS 2017 population projections; Labour Force Survey.

Adverse interest payments dynamic, driven by normalised monetary policy and elevated risk premiums

Demographic pressures are further compounded by the dynamics of the interest rate–GDP growth differential, commonly referred to as (r – g), which plays a central role in determining debt sustainability. When the average interest rate on government debt exceeds the economy’s growth rate, the real burden of debt rises over time. Over the past two decades, Israel, like other OECD countries, benefited from a favourable differential, with interest rates remaining below GDP growth (Figure 1.4, Panel A). However, this benign environment is unlikely to persist. In line with other advanced economies, the Bank of Israel has tightened its monetary policy following the post-pandemic inflation surge (OECD, 2025[8]). Moreover, Israel’s risk premium in international markets has risen in the context of the conflict (Panel B), a trend also reflected in recent downgrades and outlook revisions by major credit rating agencies.

Figure 1.4. Interest rates and risk premiums have increased, raising government borrowing costs

Panel A: Nominal GDP growth rate compared to long term nominal interest rate (%)

 

Panel B: Risk premium indicators on Israeli government debt (basis points)

Note: Long-term (10-year) interest rate is calculated at the pre-tax level and before deductions for brokerage costs. It is derived from the relationship between the present market value of the bond and its value at maturity, considering interest payments made through to maturity. The bond risk premium is calculated based on the yield spread between 10-Year USD government bonds of Israel and the United States

Sources: Bloomberg, OECD Economic Outlook database.

Mounting pressures to increase military spending, while civil expenditures are low compared with most OECD countries

Military expenditure as a share of GDP steadily declined over the two decades preceding the war, enabling Israel, alongside declining interest rates, to reduce its tax burden and public debt. However, the 7 October 2023 terror attacks and the subsequent war prompted a significant rise in defence spending (Figure 1.5). According to the 2025 budget, defence spending is expected to decrease relative to 2024, although actual execution may exceed expectations due to the prolongation of the war. It remains highly uncertain to what extent the recent rise in military spending will hold into the future. The authorities are considering permanent increases in spending and reserve duties, with significant implications for fiscal aggregates and potential negative spillovers to long-term GDP growth.

Figure 1.5. Defence spending has increased sharply

Defence spending as a % of GDP, COFOG definitions

Sources: Israel Central Bureau of Statistics; Ministry of Finance.

At the same time, Israel would need to address challenges related to low social expenditures and improve its public infrastructure. As discussed in the OECD 2023 and 2025 Economic Surveys, Israel’s core infrastructure stock lags significantly behind that of other countries, despite strong population growth (OECD, 2023[1]) (Figure 1.6), although a younger population than in most OECD countries can partially explain this spending gap (Morgan and Mueller, 2023[9]; Bank of Israel, 2024[10]).

Figure 1.6. The public capital stock is low

General government non-financial assets, as % of GDP, 2022 or the latest available year

Note: 2022 data for Israel. OECD presents the sample simple average.

Source: OECD National Accounts database.

Figure 1.7. Israel's public spending is low, especially in health and social protection

Panel A: Total government spending, % of GDP, 2023

 

Panel B: Spending by function, as a % of GDP

Note: These charts present general government expenditure across 31 OECD countries for which data is available. Social protection refers to all social protection expenditures, excluding old age (e.g. unemployment, disability, family benefits). Old-age-related spending is shown separately under Pensions. Medians are calculated across the available country sample for each function. Spending on Housing is relatively low in Israel because land privatisation is considered a negative investment.

Source: OECD.

The fiscal framework is not underpinned by official long-term expenditure projections

Since the Stabilisation Programme of 1985, which followed hyperinflation, the budget foundations and arrangements laws have given the Ministry of Finance greater control over the budget and the fiscal framework was strengthened. Currently, Israel’s fiscal framework includes annual deficit caps, a long-term expenditure ceiling, and restrictions on the government's capacity to introduce new fiscal commitments unless they are fully funded within the current fiscal structure (Box 1.1). Nonetheless, no official body in Israel regularly conducts and publishes projections on how the main fiscal expenditures and aggregates evolve in the long run (OECD, 2025[8]). Thus, the long-term expenditure ceiling is not underpinned by long-term projections and rigorous analysis of debt dynamics, limiting its ability to act as an effective fiscal anchor.

Box 1.1. Israel’s fiscal rules

Israel's fiscal policy is governed by a set of binding rules aimed at ensuring budgetary discipline and long-term economic stability. A key element is the expenditure ceiling (כלל מגבלת ההוצאה), first introduced in 2005, which limits the annual increase in central government spending based on demographic and fiscal indicators. The ceilings account for approximately 72% of general government expenditures. Health expenditures covered by the health tax, social protection spending funded by social security contributions, spending of semi-independent institutions like government hospitals and spending of local authorities are not included in the ceilings. Since 2015, the ceiling has been determined by a formula that incorporates average population growth and the debt-to-GDP ratio2:

${Expenditure Real Growth Rate}_t$= ${Average Pop Growth}_{t-4 to t-2}$ + $\frac{50\%}{{Debt-to-GDP}_{t-2}}*1\%$

If fiscal commitments exceed the permitted ceiling, adjustments must be made to align spending with the allowed cap. This cap ensures that government expenditure grows in a sustainable manner relative to economic performance, and it provides a mechanism for reducing the public debt burden. A higher debt ratio results in a lower permitted growth rate, and vice versa. Notably, if potential GDP per capita grows at a rate exceeding 1%, the expenditure ceiling implies a declining ratio of government spending to GDP over time. Nevertheless, in practice, nominal adjustments3 and repeated “one-time” modifications have introduced discretion into what was intended as a rules-based anchor. This has been true for all years except one since the rule was last modified in 2015.

The second core fiscal rule is the deficit ceiling, first introduced in 1992, which sets a cap on the permissible budget deficit as a percentage of GDP. If fiscal forecasts project that the deficit will exceed this target – after applying the expenditure ceiling – corrective measures must be taken through either spending cuts or revenue increases. Nonetheless, this ceiling has also been changed repeatedly, undermining the credibility of the medium-term targets.

A third mechanism, the numerator rule, has been in place since 2016. It limits the government from making new fiscal commitments unless these are fully funded within the existing fiscal framework. Likewise, it requires the government to publish a medium-term budget plan. This rule limits automatic budget expansion and reinforces fiscal discipline over the medium term.

Sources: The Knesset Knowledge and Information Centre, Ministry of Finance.

1.1.2. Long-term fiscal projections in OECD countries

Long-term fiscal sustainability (Box 1.2) analysis has become more common in most OECD countries. Twenty-six out of 34 OECD countries that were surveyed in the 2018 OECD Budget Practices and Procedures Survey mentioned that they publish long-term fiscal sustainability reports (OECD, 2019[11]). In more than half of the participating countries, the analysis is also debated by the legislatures (Figure 1.8). Practices across countries highlight the importance for governments to assess and manage longer-term sustainability and other fiscal risks prudently, including by publishing regular reports on long-term sustainability of the public finances to make an effective contribution to public and political discussion (OECD, 2019[11]). For most OECD countries, the importance of long-term analysis has only grown as societies age and as the impact of programmes that involve intergenerational transfers expands (OECD, 2019[11]).

Box 1.2. Defining Fiscal Sustainability

There is no consensus on how to define or measure fiscal sustainability. Most commonly, fiscal or debt sustainability is understood in the way the International Monetary Fund (IMF) defines it: “Public debt can be regarded as sustainable when the primary balance needed to at least stabilise debt under both the baseline and realistic shock scenarios is economically and politically feasible, such that the level of debt is consistent with an acceptably low rollover risk and with preserving potential growth at a satisfactory rate.” The IMF’s approach to debt sustainability is that debt cannot grow faster than income and the capacity to repay it. The debt is sustainable if projected debt-to-GDP ratios are stable, decline, and sufficiently low. In that case, a country can service its debt without the need for implausibly large policy adjustments, renegotiation, or default.

In the same vein, the European Commission, in its Fiscal Sustainability Report, defines fiscal (or debt) sustainability as the ability of a government to service its debt at any point in time. Like in the IMF approach, fiscal sustainability focuses on debt trajectories. Given government policies, solvency is considered at stake if these policies fail to generate primary surpluses large enough to stabilise the debt-to-GDP ratio. Recently, the concept has been broadened to consider forms of “sustainable debt thresholds”, considering short-term or liquidity risks, the plausibility of the required fiscal path, the probabilistic nature of fiscal sustainability, as well as fiscal risks stemming from macro-financial imbalances (“hidden debt”).

Source: Assessing Chile’s analytical framework for long-term fiscal sustainability (OECD, 2021[12]).

Figure 1.8. Most OECD countries assess long-term sustainability of public finances

Country responses to the question: does the legislature receive and debate long-term sustainability analysis?

Note: In Finland, the parliament receives long-term sustainability analysis from the government and can also ask the IFI for additional long-term analysis if it wishes. While the Latvian Fiscal Discipline Council is not required to produce long-term sustainability analysis, it is beginning to undertake this type of analysis on its own initiative.

Source: Budgeting and Public Expenditures in OECD Countries 2019 (OECD, 2019[11]).

Table 1.1 briefly describes long-term fiscal sustainability analysis practices from selected OECD countries to provide a sample of approaches to project long-term fiscal expenditures. The time horizon of the analysis needs to be sufficient to assess the budgetary implications of demographic change, usually 30 years or longer (OECD, 2021[12]). Analysis in the selected countries is generally conducted for even longer periods. Reporting is done regularly, or at the start of a new government, to contribute to the public and political discussion on public finances, with the frequency ideally specified under the law. For instance, in Slovakia, the Report on the Long-term Sustainability of Public Finances is one of the primary responsibilities of the Council for Budget Responsibility. The report highlights the contributions of recent policy changes to the long-term sustainability indicator. Publishing a sustainability report is stipulated in the Fiscal Responsibility Act, which mandates it to be published annually by 30 April and within 30 days following the establishment of a new government. Institutional arrangements also seek to ensure the independence of long-term fiscal assessments. For example, in New Zealand, the Treasury is statutorily required to use its best professional judgement about the risks and the outlook when preparing long-term fiscal statements, independently of the sitting government.

The examined countries usually focus on changes in social protection spending (including pensions), health, education, interest payments and public investment. Granularity helps identify potential pressures and informs analysis on whether the expenditure mix is conducive to fiscal sustainability (e.g. how much is spent on “productive” spending like investment, education, etc.). In Switzerland, the analysis relies on several separate projections, some of which are conducted by the line ministries.

A common starting point for fiscal sustainability analysis is the no-policy-change scenario, which outlines a central trajectory for public finances under the current fiscal framework. This baseline typically incorporates existing legislation and indexation mechanisms, with clearly defined assumptions and parameters. It is generally complemented by a set of scenario analyses applied to the baseline, offering insight into the potential range of outcomes for key fiscal variables under alternative assumptions regarding macroeconomic developments, policy settings, and demographic shifts. In Spain, for example, the independent fiscal council produces long-term projections that include demographic trends, enabling more granular scenario analysis. Interestingly, New Zealand explicitly accounts for demographic composition changes, such as the faster growth of the Māori population, in its modelling. The European Commission publishes results using two headline indicators of fiscal sustainability: the S2 indicator, which estimates the structural fiscal adjustment required to stabilise public debt in the long run, and the S1 indicator, which measures the fiscal effort necessary to reduce the debt-to-GDP ratio to 60% by 2070, thereby reflecting vulnerabilities stemming from elevated debt levels.

The analysis undertaken for Israel presented in the next section follows these trends: It provides fiscal scenarios up to 2065, starting from the last budget proposal, considers changes in the demographic composition, includes detailed projections for health, education, social protection, public pensions and interest spending, applies a series of scenario analyses, and prescribes the methodology used in detail.

Table 1.1. Insights from long-term fiscal projections in selected OECD countries

Country	Denmark	Ireland	Slovakia	New Zealand	Spain	Switzerland	European Union
Institution	The Danish Economic Council	Irish Fiscal Advisory Council	The Council for Budget Responsibility	The Treasury. It is mandated by the Public Finance Act to act independently.	The Independent Authority for Fiscal Responsibility (AIREF )	The Federal Department of Finance	EU Commission
Timeframe	Up to 2100	Up to 2050	50-years horizon	At least 40 financial years	Up to 2070	Up to 2050	Up to 2070
Starting point	A structural budget balance characterises the medium-term fiscal trajectory, which usage as a starting point to the long-term scenarios.	The projections begin with the most recent period of the officially legislated plans and extend to 2050.	The most recent medium-term forecast.	The latest period of the medium-term forecast.	The latest period of the medium-term projections, without fiscal rules’ restrictions.	The latest period of the medium-term projections.	According to the latest data.
The main fiscal vectors included in the projections	Social benefit rates, nominal public consumption expenditures, public sector wages, gross public investment, interest payments.	Pensions, other social protection, health, education, investment, interest rates.	Pensions, other social transfers, healthcare, long-term care, and education (some based on the EU ageing report).	Defence, healthcare, pensions, interest payments.	Health and long-term care, unemployment, pensions and other social protection spending, interest payments.	The impact of climate change, old-age and survivors’ insurance and disability insurance, health and long-term care, education and interest payments.	Unemployment benefits, health and long-term care, education, pensions.
Updates	Twice a year	Every five years	Every year	At least every four years	Every three years	Every four years	Every three years
Reporting	Denmark’s Convergence Programme	Long-term Sustainability Report. Methodology Report	the Long-term Sustainability of Public Finances. Methodology report	HeTirohanga Mokopuna 2021	Fiscal sustainability	Long-term sustainability outlook	The EU Ageing Report. The Debt Sustainability Monitor
Specific features	Emphasise the impact of linking the statutory retirement age to life expectancy.	Visualised the main findings and included detailed methodology notes.	Presents contributions of recent policy changes to changes in the long-term sustainability indicator.	Consists of a detailed Excel sheet with all assumptions and results. Trends in Maori and Pacific People’s demographics are considered.	AIREF also projects demographic changes, allowing the conducting of detailed sensitivity analysis.	A combination of projections undertaken by the Ministry of Finance and the line ministries.	The commission publishes a multi-dimensional approach to assess and differentiate fiscal sustainability risks in the short, medium and long term.

Source: Irish Fiscal Advisory Council (2020[13]), The Danish Government (2023[14]), Bugyi (2015[15]), New Zealand’s Treasury (2021[6]), AIReF (2023[16]), Federal Department of Finance (2024[17]), European Commission (2024[18]).

1.2. OECD approach to projecting long-term fiscal expenditures in Israel

This section outlines the method employed to project long-term macroeconomic developments and government expenditure up to 2065. First, it presents the primary data source used for the analysis and establishes the starting point for the projection. Then, it describes the approach for projecting the main macroeconomic variables, using the OECD Long-Term Model and building on the OECD’s long-standing work in this area (Johansson et al., 2013[19]; Guillemette and Turner, 2017[20]; Guillemette et al., 2017[21]; Guillemette, De Mauro and Turner, 2018[22]; Guillemette, 2019[23]; Guillemette and Turner, 2021[24]; Cavalleri and Guillemette, 2017[25]; OECD, 2025[26]). Lastly, it defines the different population, integration and policy reform scenarios for the Israeli economy that are examined.

1.2.1. The projections’ starting point

Long-run scenarios are useful for studying and illustrating broad trends that play out over long horizons. They are inherently less accurate than short-term forecasts, which are more detailed and consider the expected impact of implemented reforms. Therefore, the developed model incorporates published short-term forecasts for both the leading macroeconomic indicators, like GDP and government expenditures, before initiating the long-term analysis.

The short-term projections for the main macroeconomic variables (up to 2026) are based on the OECD Economic Outlook, published twice a year. According to the latest OECD projections (June 2025), Israel’s nominal GDP is expected to reach 2.28 trillion shekels in 2026, following a growth of 5.4% in 2025 (3.3% in real terms) and 8.1% (4.9%) in 2026 (OECD, 2025[27]). The Ministry of Finance’s macroeconomic projections are broadly aligned with these forecasts.

For total government spending and spending on its main components, the projection’s starting point is based on the most recent Classification of the Functions of Government (COFOG) data, currently available for 2024. Developed by the OECD, COFOG categorises government expenditure data from the System of National Accounts based on the purpose for which the funds are allocated and contains information for the general government (used for the projections) and for central government, local government, social security funds and extra-budgetary units (Box 1.3). The 2024 data are then indexed according to the last budget (2025) to incorporate current trends and government priorities. For this purpose, each 8-digit budget item (תקנה) is allocated to the relevant second-level COFOG function according to the most prominent expenditure in each budget item4. Table 1.2 illustrates this matching for a few budget items. For non-budgetary expenditures – primarily those of the National Insurance Institute – the starting point is set at 2024. Military spending is assumed to evolve according to the Nagel committee recommendations up to 2029 to avoid including one-off expenditures in the base year5.

Box 1.3. The Classification of the Functions of Government (COFOG) data

Developed by the OECD, the Classification of the Functions of Government (COFOG) classifies government expenditure data from the System of National Accounts by the purpose for which the funds are used. First-level COFOG data splits expenditure data into ten “functional” groups or sub-sectors of expenditures (General public services, Defence, Public order and safety, Economic affairs, Environmental protection, Housing, Health, Recreation, culture and religion, Education and Social protection). A second-level COFOG further splits each first-level group into up to nine sub-groups. First-level COFOG data are available for 34 out of the 38 OECD countries, while second-level COFOG data are usually available for OECD European countries, Australia, Colombia, Costa Rica, Japan, and Israel.

The Israeli general government expenditures included in COFOG are collected from multiple sources: quarterly budget reports from the Budget management system, financial reports of the National Insurance Institute, financial reports of local authorities, regional and religious councils, city unions and national health care providers' data from the NPI’s survey. The CBS adjusts these data to use accrual accounting, meaning that flows are recorded according to the point in time when economic value is created, transformed, exchanged, transferred, or extinguished (United Nations, 1993[28]). This approach also includes Financial Intermediation Services Indirectly Measured (FISIM) and the non-market output of the Central Bank.

Source: OECD Government at a Glance (OECD, 2025[29]), Israel Central Bureau of Statistics.

Table 1.2. The relationship between budget and COFOG items: an illustration

Budget item (8-digit)	Item’s description	Expected expenditure in 2025, million shekels	COFOG function (2-digit)
20670210	Educational activities during school holidays	317	9.2 (Secondary education)
13040101	Earned income tax credits	1,935	10.7 (Social exclusion n.e.c)
07800301	Security for education facilities	311	3.1 (Police services)
05511315	Acquisition of vehicles	170	1.1 (Executive and legislative organs, fiscal and external affairs)

Source: OECD calibrations to CBS and the Ministry of Finance data.

1.2.2. Looking beyond the short-term

For projecting expenditures in each year up to 2065, the model relies on the Israeli CBS’s demographic projections, an adapted version of the OECD Long-Term Model, a detailed set of equations to project the main categories of government spending, indexation formulas, and exogenous projections and assumptions. More specifically, expenditure functions were projected using one of the following methods: (1) a detailed model considering the main features of the expenditure category; (2) assumptions made on the basis of discussions with experts from the Ministry of Finance and academia; an approach that was taken for projecting military and transport spending; (3) the Ministry of Finance models for projecting expenditures on budgetary pensions and capital transfers to old pension funds (4) indexation to modelled categories; and (5) by assuming that the government will seek to maintain a constant level of service provision per capita, as described in (Guillemette and Turner, 2017, p. 9[20]). In some sub-categories, more than one method was used. Table 1.3 reports the method used for projecting each second-level COFOG category. Overall, about 63% of total expenditures are projected using detailed models; about 20% are projected using simple exogenous assumptions, and the rest are projected using formulas that aim to index the expenditure category to a modelled category or keep the service levels constant. All vectors rely heavily on two main inputs: demographic and potential GDP growth projections.

Table 1.3. Government spending sorted by COFOG and projection method

COFOG function	2-digit code	Expenditures in 2024 (in millions NIS)	Method to project spending up to 2025	Projected expenditures in 2025 (in millions NIS)	Long-term projection method
General public services	1	105,222		109,705
Executive and legislative organs, fiscal and external affairs	11	16,212	2025 budget proposal	17,592	Constant service levels
Foreign economic aid	12	171	2025 budget proposal	221	Constant service levels
General services	13	10,606	Indexation starting from 2024 COFOG data	11,159	Constant service levels
Basic research	14	8,707	Indexation starting from 2024 COFOG data	9,161	Constant service levels
R&D General public services	15	-		-
General public services n.e.c	16	78	2025 budget proposal	10	Constant service levels
Public debt transactions	17	68,517	Detailed model starting from 2024 COFOG data	70,581	Detailed model
Transfers of a general character between different levels of government	18	931	Indexation starting from 2024 COFOG data	980	Constant service levels
Defence	2	181,015		133,951
Military defence	21	178,333	Exogenous assumption
Civil defence	22
Defence n.e.c	25	2,682
Public order and safety	3	30,461		27,995
Police services	31	17,807	2025 budget proposal	16,795	Constant service levels
Fire-protection services	32	1,848	2025 budget proposal	1,645	Constant service levels
Law courts	33	6,080	2025 budget proposal	5,152	Constant service levels
Prisons	34	4,455	2025 budget proposal	4,264	Constant service levels
R&D Public order and safety	35	-		0
Public order and safety n.e.c	36	271	2025 budget proposal	140	Constant service levels
Economic affairs	4	67,633		76,159
General economic, commercial and labour affairs	41	3,455	2025 budget proposal	3,776	Constant service levels
Agriculture, forestry, fishing and hunting	42	4,518	2025 budget proposal	5,847	Constant service levels
Fuel and energy	43	797	2025 budget proposal	615	Constant service levels
Mining, manufacturing and construction	44	3,334	2025 budget proposal	4,112	Constant service levels
Transport	45	42,368	2025 budget proposal	45,426	Exogenous assumption
Communication	46	453	2025 budget proposal	95	Constant service levels
Other industries	47	-2,674	Indexation starting from 2024 COFOG data	-2,813	Constant service levels
R&D Economic affairs	48	2,698	2025 budget proposal	2,372	Constant service levels
Economic affairs n.e.c	49	12,694	2025 budget proposal	16,730	Constant service levels
Environment protection	5	10,723		10,970
Waste management	51	8,887	Indexation starting from 2024 COFOG data	9,351	Constant service levels
Waste water management	52	898	Indexation starting from 2024 COFOG data	944	Constant service levels
Pollution abatement	53	164	2025 budget proposal	21	Constant service levels
Protection of biodiversity and landspace	54	182	2025 budget proposal	31	Constant service levels
R&D Environmental protection	55	2	2025 budget proposal	2	Constant service levels
Environment protection n.e.c	56	590	Indexation starting from 2024 COFOG data	621	Constant service levels
Housing and community amenities	6	865		839
Housing development	61	-5,090	Indexation starting from 2024 COFOG data	-5,427	Constant service levels
Community development	62	4,106	Indexation starting from 2024 COFOG data	4,320	Constant service levels
Water supply	63	1,097	Indexation starting from 2024 COFOG data	1,154	Constant service levels
Street lighting	64	752	Indexation starting from 2024 COFOG data	791	Constant service levels
R&D Housing and community amenities	65	-		-	Constant service levels
Housing and community amenities n.e.c	66	-		-	Constant service levels
Health	7	103,265	2025 budget proposal	105,316	Detailed model
Medical products, appliances and equipment	71	11,593	Treated in one model
Outpatient services	72	34,161
Hospital services	73	53,690
Public health services	74	1,764
R&D Health	75	7
Health n.e.c	76	2,050
Recreation, culture and religion	8	26,200		27,712
Recreation and sporting services	81	6,486	Indexation starting from 2024 COFOG data	6,825	Constant service levels
Cultural services	82	10,618	Indexation starting from 2023 COFOG data	11,172	Constant service levels
Broadcasting and publishing services	83	2	2025 budget proposal	6	Constant service levels
Religious and other community services	84	7,260	Detailed model starting from 2024 COFOG data	7,639	Detailed model
R&D Recreation culture and religion	85	24	2025 budget proposal	83	Constant service levels
Recreation, culture and religion n.e.c	86	1,810	2025 budget proposal	1,988	Constant service levels
Education	9	127,953		131,172
Pre-primary and primary education	91	59,100	2025 budget proposal	59,606	Detailed model
Secondary education	92	29,524	2025 budget proposal	29,917	Detailed model
Post-secondary non-tertiary education	93	1,637	2025 budget proposal	2,020	Detailed model
Tertiary education	94	23,161	2025 budget proposal	24,229	Detailed model
Education not definable by level	95	885	2025 budget proposal	689	Detailed model
Subsidiary services to education	96	8,713	Indexation starting from 2023 COFOG data	9,260	Detailed model
R&D Education	97	8	2025 budget proposal	3.7	Detailed model
Education n.e.c	98	4,925	2025 budget proposal	5,446	Detailed model
Social protection	10	235,553		238,771
Sickness and disability	101	66,891	Detailed model starting from 2024 COFOG data	73,747	Detailed model & indexations
Old age	102	103,112	Detailed model starting from 2024 COFOG data & MoF projections	102,287	Detailed model & MoF projections
Survivors	103	9,390	Detailed model starting from 2024 COFOG data	10,450	Detailed model
Family and Children	104	22,289	Detailed model starting from 2024 COFOG data	23,486	Detailed model
Unemployment	105	7,334	Detailed model starting from 2024 COFOG data	6,413	Detailed model
Housing	106	11,347	2025 budget proposal	7,050	Indexation to a modelled vector
Social exclusion n.e.c	107	8,097	Detailed model starting from 2024 COFOG data	8,142	Detailed model & indexations
R&D Social protection	108	-	-	-	Indexation to a modelled vector
Social protection n.e.c	109	7,092	2025 budget proposal	7,195	Indexation to a modelled vector
Total		888,890		862,590

Note: In COFOG, interest payments written under spending on public debt transactions (function 1.7) are recorded on an accrual basis and include indexation, premiums, and discounts. Therefore, they differ from the figures reported by the MoF’s general accountant. Land privatisation is recorded in COFOG under function 61 (housing developments) as the disposal of non-produced non-financial assets. In 2024, it totalled about NIS 20 billion.

Source: CBS and OECD calibrations.

1.2.3. Demographic projections

The analysis relies on the CBS’s most recent demographic projections, published in 2017, based on population data from the end of 2015. These projections estimate the population up to 2065 for each year and specific age for six population groups: Non-haredi Jewish and other (NHJO) men, NHJO women, Haredi men, Haredi women, Arab men and Arab women. The Haredi (ultra-Orthodox) population was defined based on self-determination, as investigated in the Social Survey conducted by the Central Bureau of Statistics, with additional information from the Population Registry. A key assumption in the CBS projections is the absence of inter-group mobility; individuals are projected to remain in their birth group (e.g., someone born Haredi is assumed to remain Haredi throughout their life).

Since its publication by the CBS, population growth has broadly aligned with these projections. However, the overall trends overlook crucial nuances. On the one hand, migration to Israel was higher than expected, mainly due to a significant increase in the number of migrants from Russia and Ukraine since the outbreak of the war in Ukraine; a phenomenon which is not expected to continue. On the other hand, fertility was significantly lower than expected in the median variant of the CBS projections and much closer to the fertility assumed in the low variant (Figure 1.9). To consider the lower-than-expected fertility rates in the baseline scenario without making significant modifications to life expectancy, the model relies on the actual data for 2022 and a mix of growth rates from the low and median variants in CBS’s projections. More specifically, the age cutoff for using the median variant growth rates was t (year) minus 2022 minus one. So, for example, in 2030, the model used the growth rates in the low variant for ages 0 to 9 (2030-2022-1) and the median variant for all ages above 9. Notably, the recent CBS updates on population size, based on data from the latest census – show an increase in total population due to the inclusion of foreign workers and a decrease in total population because of a methodological change regarding the definition of outmigration – are not considered in the analysis. This is because the current population projections, which underpin the analysis, do not consider these modifications.

Figure 1.9. Actual fertility is lower than was expected in 2017

Actual vs. projected number of births, 2016-2024

Note: The birth numbers in the demographic projections were estimated according to the number of children aged 0 years in each period.

Source: OECD estimations based on CBS data.

According to this mixed variant, the population of Israeli citizens is projected to rise from 9.6 million in 2022 to approximately 17 million by 2065, representing the fastest expected population growth among OECD countries. At the same time, the share of the working-age population (25-64) is expected to rise from 53% to 56%, the share of minors (0-18) to decline from 34% to 27% and the share of the elderly population to increase from 13% to 18% (Figure 1.10). Based on the 2022 actual population data and the growth rates of the original CBS median and low variants, two adjusted scenarios (adjusted median and adjusted low) were created for the sensitivity analysis (Figure 1.11). The United Nations projections for Israel are broadly aligned with the CBS’s low variant.

Figure 1.10. Israel’s population is projected to age

Projected age structure of the Israeli society, share of the total population

Source: OECD elaborations based on customised CBS 2017 population projections.

Figure 1.11. Israel’s population is projected to rise considerably, in all scenarios

Note: The UN estimates a lower population in Israel than the CBS at the starting point. To facilitate comparison, the UN projections were aligned with the CBS starting point. Then, the adjusted UN projections apply the population growth rate from the UN medium variant projections.

Source: OECD elaborations based on customised CBS 2017 population projections and the UN Population Division data.

Box 1.4. Differences between the Israeli CBS and the UN population projections

The Israeli CBS projects higher population growth than the United Nations Population Division, primarily due to differing views on future fertility. The CBS estimates fertility separately by age, sex, and population group, using expert elicitation to guide long-term assumptions. Specifically, experts provide expectations for future fertility in each group, and the CBS averages these to generate forward-looking fertility rates. In the medium variant, the model projects that fertility, particularly among the Haredim, will remain well above the replacement level (2.1 children per woman) throughout the projection period. Fertility rates are then applied to the previous year’s population to estimate births.

The UN’s World Population Prospects uses a Bayesian hierarchical model to project fertility for all countries. This model assumes that national fertility rates will gradually decline and converge toward lower levels over time, following global historical patterns of fertility transition. While current fertility levels in Israel are taken into account, the model does not distinguish between population subgroups. Instead, it projects that Israel’s total fertility rate will fall below replacement level in the long run, reaching around 2.08 by 2065 and continuing to decline thereafter. To reflect uncertainty, the UN provides probabilistic intervals around its median trajectory. For Israel, the 80% prediction interval ranges from about 1.57 to 2.82 births per woman in 2065.

Source: CBS, United Nations, World Population Prospects 2024.

1.2.4. The model for long-term economic growth and its main drivers

The OECD Long-Term Model provides long-term scenarios for economic developments under the assumption that no policy change will occur, except for changes to the legal retirement age that have already been legislated. This analysis employs the OECD Long-Term Model with a few modifications. Differences in projections relative to other OECD publications relying on the Long-Term Model are mainly due to these modifications. In particular, the adapted model relies on the Israeli CBS demographic projections (instead of the UN projections), considers changes in the population composition, and modifies the assumed production function to account for hours worked and the skills composition.

The model consists of a set of dynamic projection rules and identities for variables of interest. The backbone of the model is a projection for potential output (Y) based on a Cobb-Douglas production function with constant returns to scale featuring physical capital (K) and quality-adjusted labour input (QALI) as production factors plus labour-augmenting technological progress (E, referred to as overall trend labour efficiency), so that:

$Y={(E\cdot QALI)}^{\alpha }\cdot K^{1-\alpha }$

Substituting K using the capital-to-output ratio in the production function gives:

$Y={(E\cdot QALI)}^{\alpha }\cdot {\left(\frac{K}{Y}*Y\right)}^{1-\alpha }$

This can be rearranged as:

$Y=\mathit{ }{\left[{(E\cdot QALI)}^{\alpha }\mathit{ }\cdot {\left(\frac{K}{Y}\right)}^{1-\alpha }\right]}^{\frac{1}{\alpha }}$

Taking time differences of the log-linear form yields a growth rate equation for output:

$∆y_t= ∆e_t+ ∆{\mathit{qali}}_t+ \frac{1-\alpha }{\alpha } *∆\left(\frac{k_t}{y_t}\right)$

where lower-case letters denote logarithms and $\alpha$ is the labour income share, assumed to be 0.67 (as for all OECD countries6). This equation shows that potential output grows with labour augmenting technological progress (trend labour efficiency), labour input quality and quantity and capital deepening, measured by the change in capital-to-output ratio, scaled by $\frac{1-\alpha }{\alpha }$.

Projections of potential output through 2065 are derived by modelling the trend dynamics of each production factor. The frameworks used to project trend labour efficiency (E) and capital accumulation are consistent with those employed for all OECD countries in the regularly updated OECD Long-Term Model (OECD, 2025[26]). For labour input, a customised approach was developed to reflect demographic and employment patterns unique to Israel (see below).

Trend labour efficiency

Trend labour efficiency is projected using a framework that mixes absolute and conditional convergence elements. Convergence is absolute as trend labour efficiency ultimately reaches a common frontier level, and it is conditional insofar as the speed at which this occurs is a function of country-specific characteristics. The framework is based on a model estimated over the 1996-to-2023 period, using data for 139 countries. The estimated coefficients are then incorporated into the closely related projection equation:

$∆e_t=\phi +{\delta }_t\left(e_{t-1}-e_{t-1}^{*}\right)-∆{DAMAGE}_t+{\mu }_t$

${\delta }_t={\gamma }_0+{\gamma }_1{RULELAW}_t+{\gamma }_2{KOFECGI}_t+{\gamma }_3{MACROSTABILITY}_t$

${\mu }_t=\rho \bullet {\mu }_{t-1}$

The projected growth rate of trend labour efficiency ($∆e_t$) is the sum of four components:

1. Rate of global technical progress ($\phi$). This component is set to 1% in the baseline scenario. This assumption is based on the geometric mean trend labour efficiency growth rate of advanced G20 economies over the past 30 years.

2. Convergence to frontier (${\delta }_t\left(e_{t-1}-e_{t-1}^{*}\right)$). This component captures the effect of catching up towards the frontier labour efficiency level ($e_t^{*}$), assumed to be that of the United States. The growth impetus depends on how far a country is relative to the frontier $\left(e_{t-1}-e_{t-1}^{*}\right)$ and on a country-specific speed of convergence (${\delta }_t$), which is modelled as a function of a country’s framework conditions. Those include the quality of governance (based on the World Bank’s Rule of Law indicator, ${RULELAW}_t$), the degree of economic globalisation (based on the KOF Swiss Institute’s economic globalisation index, ${KOFECGI}_t$) and an index of macroeconomic stability (based on the level and variance of a moving average of headline inflation, ${MACROSTABILITY}_t$). A country with mean scores on all three structural indicators would close approximately 1% of any remaining gap with frontier labour efficiency annually. Better scores on the structural indicators raise this speed and vice-versa (based on estimated coefficients ${\widehat{\gamma }}_1$, ${\widehat{\gamma }}_2$ and ${\widehat{\gamma }}_3$). Framework conditions are assumed to remain at initial values throughout the entire projection period7, and so are convergence speeds. For Israel, the convergence speed associated with framework conditions ${\delta }_t$ is close to the US level and lower than in the EU (Figure 1.12), mainly due to a lower score in the World Bank’s Rule of Law indicator. If the Rule of Law indicator had not deteriorated in the last years (from 1.13 in 2015 to 0.78 in 2023), the trend of labour efficiency growth could have been about 0.03% faster.

Figure 1.12. The convergence speed to the labour efficiency frontier associated with framework conditions is low

Total difference (higher = faster convergence)

Note: Positive values indicate a higher convergence speed than a country with mean scores on all three framework conditions, which would be 1% per year, and vice-versa for a negative value. Nonetheless, the actual convergence speed also depends on the labour efficiency gap from the US. Aggregates are computed using fixed 2021 Purchasing Power Parity exchange rates.

Source: OECD Long-Term Model.

3. Climate damage (${∆DAMAGE}_t$). The output costs associated with global warming are assumed to manifest primarily via lower trend labour efficiency (with knock-on effects on capital accumulation).

4. Momentum (${\mu }_t$). This residual factor captures that part of the trend of labour efficiency growth at the starting point, which is unexplained by other factors. The initial value decays over time with a half-life of about 6 years based on the estimated coefficient $\widehat{\rho }$. This decay rate ensures a smooth transition from the estimated trend of labour efficiency growth rates at the outset to the longer-term projections. This factor's gradual decline implicitly assumes that the growth determinants it identifies are persistent but not permanent.

In the long run, trend labour efficiency growth in all countries converges to the assumed exogenous rate of global technological progress (1% per annum), although this would occur far beyond the 2065 projection horizon for Israel.

Capital intensity

In the short to medium run, the primary source of variation in the capital stock is the net investment rate at the starting point. If it is higher than the rate that would be consistent with keeping the initial capital-to-output ratio stable, given projections of trend in quality-adjusted labour input and trend labour efficiency, the capital-to-output ratio rises and contributes positively to potential output growth, and vice versa. In the longer run, investment rates adjust dynamically to target a capital-to-output ratio of 3.4, a historical average among advanced countries. Based on this method, the capital-to-output ratio is projected to increase gradually during the projection period, but to remain below the historical average among advanced economies in 2065 (Figure 1.13). This projected path of the capital-to-output ratio reflects a moderate increase in gross fixed capital formation over the medium term, followed by a stabilisation, which is consistent with the assumed trajectory of public investment8 (see below).

Figure 1.13. The capital-to-output ratio is projected to rise gradually

Source: OECD Long-Term Model.

Trend in quality-adjusted labour input

Labour input projections in the model are structured around five key drivers: (1) the size of the working-age population (defined as individuals aged 15 to 74); (2) its demographic and age composition; (3) employment rate trends by age, sex, and population group; (4) average hours worked per employed person; and (5) the evolving composition of worker quality. These components are integrated using the QALI (Quality-Adjusted Labour Input) framework, in which total hours worked are adjusted by the relative productivity – or "quality" – of different types of workers.

To clarify the structure of trend labour inputs, an intermediate index of unadjusted labour input – RawLabour – is defined to capture the total volume of hours worked in the economy before adjusting for labour quality. This index is defined, for each year 𝑡, as the sum across all age, gender, and population groups of the employment rate (ER), average Hours Worked Per Employed (HWPE) person, and the population (POP) of each group. It is expressed as:

$RawLabour=\sum _g{ER}_{g,t}* {\mathrm{H}\mathrm{W}\mathrm{P}\mathrm{E}}_{g,t}* {POP}_{g,t}$

Each component of RawLabour is projected independently.

• The size and composition of the working-age population follow the demographic projections described above and are exogenous in the model.

• Trends in employment rates according to sex, age, and population group are projected using a cohort approach (Cavalleri and Guillemette, 2017[25]), drawing on trends observed between 2017-18 and 2022-23 based on data from the CBS’s Labour Force Survey. For most population groups, the different employment propensities of existing cohorts are used to project future employment rates. New cohorts' entry and exit rates are assumed to mirror the youngest available cohorts in the data. However, this approach was adjusted in the case of Arab women. Applying the same assumption to this group would likely understate future employment rates, as it does not account for the significant and sustained increase in participation among younger Arab women in recent decades. The employment rates of Arab women aged 25 to 34 rose from approximately 30% in 2002 to 49% in 2023, alongside a rapid increase in years of education. To better reflect this structural shift, the projections assume higher labour market entry rates for future generations of Arab women than those observed in today’s youngest cohorts. The already-legislated increase in the legal retirement ages for women is incorporated in the projections for the employment rates of people aged 55 and over.

• In the baseline, trends in working hours according to sex, age, and population group are assumed to remain constant at their 2022-23 levels (2018-2019 for Arab men and women9) for all population groups. This assumption is modified as part of a scenario analysis (see Section 1.2.5).

Then, to incorporate the significant disparities in hourly wages between groups (as discussed above), the framework adjusts RawLabour using the Quality-Adjusted Labour Input (QALI) methodology, as in (Ward and Zinni, 2024[30]) and that is used by the UK Office for National Statistics (ONS, 2021[31]).

In this framework, workers are categorised based on identifiable characteristics — herein by age, gender, and population group — and the hours worked by each group are weighted according to their share in total labour income. The rationale for this approach is that, in competitive labour markets, different factors of production should be remunerated according to their productivity. Consequently, relative labour income shares are used as a proxy for the relative productivity or "quality" of different types of labour inputs.

The total quality-adjusted labour input (QALI) in year t is therefore calculated as:

$QALI=\sum _g{w}_{g,t }{* ER}_{g,t}* {\mathrm{H}\mathrm{W}\mathrm{P}\mathrm{E}}_{g,t}* {POP}_{g,t}$

The relative income weight ($w_{g,t }$) is calculated based on the share of labour income of group g in total labour income. To smooth potential volatility and ensure consistency over time, these weights are calculated as the average of time t and t-1, as in a Törnqvist index. This average is then applied to the log change in hours worked of each group to compute contributions to overall labour input growth. Using log changes facilitates the decomposition of total labour input growth into quantity and composition effects, with the difference between QALI and RawLabour capturing changes in the composition of the workforce.

In the model, the relative income shares are proxied using administrative data on average wages by age, gender, and population group – provided to the OECD by the Israeli CBS – multiplied by the total projected employment of each group. In the baseline scenario, these wage differentials are assumed to remain constant throughout the projection period.

1.2.5. Scenarios analysis

The baseline scenario assumes that current labour market trends persist. Accordingly, employment rates of older women are projected to continue to rise due to cohort effects and the increase in the statutory retirement age. In contrast, employment rates of young Haredi men and older Arab men are projected to remain low. The employment of Arab women and older Haredi women is projected to continue growing, while the employment of NHJO men is projected to remain broadly at its current level (detailed results are described below).

Furthermore, the model provides scenarios based on assumptions concerning the convergence of employment and productivity among population sub-groups. Notably, it includes a headwind scenario in which there is no convergence in employment and productivity between the population groups and a faster convergence scenario (Melting pot) where employment and productivity converge more swiftly (but not entirely). A quicker labour market convergence speed is optimistic but should be seen as feasible if essential reforms are implemented. The faster convergence (Melting pot) scenario assumes different labour market entry and exit rates, allowing Haredi men to close about 75% of their current labour market participation gap in prime ages with Jewish non-ultra-orthodox men in 35 years (up to 2060) and Arab women to close 90% of the gap with Jewish non-ultra-orthodox women. These assumptions can be compared with the targets the Israeli government has set for 2030, based on recommendations of an independent committee led by academic experts (Eckstein, 2020[32]). These targets were set based on data until 2018. They represent a goal of shrinking 42.5% of the participation gaps between Arab women and Haredi men with the majority group in 12 years, a faster convergence than in the scenario described above. In addition, the pay gaps between Haredi women and Arab men aged 25-39 and the respective majority groups are supposed to shrink by about 25-30% by 203010, reflecting a more than 50% shrinkage by 2060 assumed in the faster convergence scenario.

Two additional scenarios are constructed for slower and faster population growth. An Ageing-related policy reforms scenario (hereafter Policy reforms scenario) links the statutory retirement age to life expectancy for both men and women at a rate of 2/3:1, following the legislated increase until 2032 and a subsequent full alignment of the female retirement age with that of men by 2040 (Figure 1.14). The impact of a 1-year increase in the statutory retirement age was calibrated to raise the average effective retirement age by about 4.2 months, based on Morgavi (2024[33]). This policy scenario also assumes lower morbidity among older people to capture better the potential impact of healthy ageing on public spending. To reflect the potential impact of lower morbidity than in the baseline among older people on GDP, it was assumed that if life expectancy at a given age increases by one year, individuals belonging to this age group will have the same employment rate as individuals who are 0.1 years younger11, as in (André, Gal and Schief, 2024[5]). Table 1.4 outlines the primary assumptions across the various scenarios.

Figure 1.14. In the reform scenario, the statutory retirement age would be around 68.5 in 2065

Note: The baseline scenario considers the legislated increase in the female retirement age under implementation until 2032. The reform scenario assumes a full alignment of the male and female retirement age at age 67 from 2040, maintaining the current speed of adjustment. From 2040, an increase of both retirement ages at a rate of 2/3 of the gains in life expectancy at age 65 is assumed.

Source: OECD elaborations, life expectancy data based on CBS mortality rates.

Table 1.4. Underlying assumptions in the different scenarios

Scenario	Population Assumption	Employment Rates	Hours Worked	Hourly Wage	Retirement Age	Healthy ageing ratio
Baseline	CBS Low Variant for young cohorts & Median Variant for older cohorts	Based on a cohort model estimating trends separately by gender and population group, considering trends between 2022–23 vs 2017–18. Includes a positive trend for young Arab women joining the labour force and higher exit rates for Haredi men.	Constant at 2022–23 averages (Arabs: 2018-19 average)	Constant at 2022 levels	Men: 67 (constant); Women: gradual increase to 65 by 2032	0.5
Frozen Rates	Same as Baseline	Remain at their 2023 levels	Same as Baseline	Same as Baseline	Same as Baseline	0.5
Melting pot	Same as Baseline	Partial closure of Haredi/Arab entry/exit gaps: Haredi men: close 80% of the entry gap vs NHJO men by 2060, 30% of the exit gap from 2035 Arab men: close 60% of the entry gap by 2060, 30% of the exit gap from 2035 Haredi & Arab women: close 85% of the entry gap vs NHJO women by 2060, 42.5% of the exit gap from 2035	Closure of 50% of Haredi/Arab vs NHJO gaps by 2060.	Closure of 50% of Haredi/Arab vs NHJO gaps by 2060.	Same as Baseline	0.5
Melting pot – only Arabs	Same as Baseline	Partial closure of Arab entry/exit gaps: Arab men: close 60% of the entry gap by 2060, 30% of the exit gap from 2035 Arab women: close 85% of the entry gap vs NHJO women by 2060, 42.5% of the exit gap from 2035	Closure of 50% of the Arab vs NHJO gaps by 2060.	Closure of 50% of the Arab vs NHJO gaps by 2060.	Same as Baseline	0.5
Melting pot – only Haredim	Same as Baseline	Partial closure of Haredi/Arab entry/exit gaps: Haredi men: close 80% of the entry gap vs NHJO men by 2060, 30% of the exit gap from 2035 Haredi women: close 85% of the entry gap vs NHJO women by 2060, 42.5% of the exit gap from 2035	Closure of 50% of the Haredi vs NHJO gaps by 2060.	Closure of 50% of Haredi vs NHJO gaps by 2060.	Same as Baseline	0.5
Slower Population Growth	CBS Low Variant, re-benchmarked to 2022	Same as Baseline	Same as Baseline	Same as Baseline	Same as Baseline	0.5
Faster Population Growth	CBS Median Variant, re-benchmarked to 2022	Same as Baseline	Same as Baseline	Same as Baseline	Same as Baseline	0.5
Ageing-related policy scenario	Same as Baseline	Same as Baseline	Same as Baseline	Same as Baseline	Men: Increasing to 68.5 from 2040 to 2065; Women: Increasing to 67 until 2040 and gradually to 68.5 from 2040 to 2065	0.6

Note: To reflect convergence across the full lifecycle and its expected impact on occupational distribution, the Melting pot scenario assumes that both entry and exit rates gradually align across groups, with exit rates adjusting more slowly to capture the delayed nature of such changes. The healthy ageing effect accounts for reductions in age-spending profiles as life expectancy increases. It assumes that as people live longer, the years of morbidity decline, thereby lowering the per-capita costs of each age group. This is modelled by shifting the age-spending profiles downward in proportion to the projected gains in life expectancy. The magnitude of this shift depends on the assumed ratio of healthy years gained to years added to life expectancy (0.5 in the baseline).

Source: OECD elaborations.

1.3. Stylised scenarios for the Israeli economy up to 2065

This section first presents the potential GDP projections of the baseline scenario. It then outlines how the introduction of a set of policy changes affecting skills accumulation and employment of different population groups, as well as the sensitivity of results to demographic projections, would change these potential GDP outcomes.

1.3.1. Potential GDP growth in the baseline scenario

In the absence of any policy change, Israel’s annual potential output growth is projected to gradually moderate from around 3½ per cent currently, to about 3¼ per cent in the first part of the 2030s, around 3% in the early 2040s and 2½ per cent at the end of the projection period (2065) (Figure 1.15, Panel A). The decline leading up to 2040 is primarily due to an anticipated slowdown in labour efficiency caused by a loss of growth momentum that cannot be attributed to Israel’s fundamental characteristics and, to a much lesser extent, increasing damages associated with global warming (the latter subtracting slightly less than 0.1% of trend labour efficiency growth annually). After 2040, the further decline is mainly attributed to a slowing growth of the working-age population (15-74). From 2040 to 2065, the working-age population's annual growth is expected to decline from about 1.6% to 1%.

Potential GDP per capita growth, which is more closely related to the evolution of living standards, is projected to remain largely stable through 2065 (Panel B). When analysing GDP per capita growth, what matters is the share of the working-age population among the total population. This share is projected to rise according to the population projection’s mixed variant described above, contributing to GDP per capita growth. The positive contribution of the trend employment rate component is attributed to a significant rise in female employment rates (especially in older ages and among Arab women, see below) that will more than offset the projected decline in employment rates of men. In contrast, trends in the hours worked and labour quality are expected to slow GDP per capita growth, especially up to 2040, along with the increase in the share of the Haredi population among the total population. The contribution of alterations in the age composition of the working-age population to potential growth is approximately zero12.

The positive contribution of the capital-to-output component to GDP and GDP per capita growth is driven by a relatively low capital ratio at the start of the projection period. Given that the underlying model targets a common capital-to-output ratio in all OECD countries in the very long run, countries such as Israel, with initially lower ratios, tend to have more positive contributions from this component.

Figure 1.15. Output per capita growth is projected to remain stable despite shifting demographics

Note: As mentioned above, the labour quality contribution is calculated as the difference between QALI and RawLabour (=total hours). Therefore, if total hours decline, the contribution of Labour quality would be positive even without a change in QALI.

Source: OECD calculations.

As part of the analysis, wage growth across the population is assumed to track productivity per person employed. This measure is projected to increase by approximately 1.4% annually through 2065, 0.2 percentage points lower than GDP per capita growth. The difference reflects a rising employment-to-population ratio, driven by two key factors: a modest increase in the share of the working-age population and continued improvements in employment rates, particularly among women.

The baseline scenario features some convergence in living standards between Israel and the United States, as measured by potential output per capita in USD at fixed 2021 PPPs (Figure 1.16). Currently, Israel’s potential GDP per capita is 64% of the US level. This ratio is projected to progress to 66% by 2045 and 75% by 2065. The main reason for this convergence is higher anticipated labour efficiency growth (about 1.4% annually) in Israel and, to a lesser extent, more favourable working-age population growth (improving the employment-to-population ratio). The higher anticipated growth in labour efficiency in Israel compared to the United States is attributed to Israel's current low productivity level, while, as previously mentioned, the Israeli-specific convergence speed related to framework conditions is modest. Enhancing the quality of governance and institutions could further boost labour efficiency and, therefore, should be regarded as crucial for quicker convergence.

Figure 1.16. Some convergence in living standards vis-à-vis the United States is expected

Potential output per capita at 2021 Purchasing Power Parities, USA = 1.0

Note: Projections for the United States are based on the OECD Long-Term model, with the latest Economic Outlook serving as the starting point.

Source: OECD calculations.

The projected potential GDP per capita growth in the baseline (about 1.6% annually) is considerably higher than in the Bank of Israel’s projections, published in 2019. The Bank of Israel projected an annual increase in GDP per capita of about 0.9% up to 2035 and 0.6% afterwards. The higher long-term growth projected in this analysis is due to the higher projected working-age population share, a result of the lower assumed fertility, and stronger labour efficiency (a term closely related to TFP) growth. As mentioned above, the labour efficiency growth projected for Israel as part of this analysis is based on the OECD Long-Term model, which uses a common method for all OECD countries. Nonetheless, the significant gap between results highlights the uncertainty in long-term economic projections, especially when it comes to productivity growth.

1.3.2. Potential GDP growth in alternative scenarios

In the baseline scenario, future trends in labour inputs were estimated based on the continuation of recent trends, resulting in limited economic integration of the Arab and especially Haredi communities with the majority population. However, as highlighted in the OECD Economic Surveys of Israel, the economic integration of these minority groups is highly dependent on government policies. Conditioning schools' funding to teach English and mathematics, equalising per-pupil funding across schools with equal socio-economic characteristics and withdrawing subsidies discouraging labour-market participation, for example, could result in faster integration than in the baseline (OECD, 2025[8]). On the contrary, higher subsidies for Haredi men to study in religious seminars (Yeshivas and Kollels) or a rise in labour market discrimination could lead to slower economic integration. Table 1.5 presents the leading employment and GDP variables for the three economic integration scenarios Baseline, Melting pot and Frozen rates scenarios described in Table 1.4 above. The difference between scenarios lies in the quality-adjusted labour inputs, while capital deepening and trend labour efficiency are assumed to remain as in the baseline. The projected employment rates by population group, gender and age are presented in the annex of this chapter (Annex 1.A).

A comparison of employment trends across scenarios illustrates the potential implications of demographic and labour market shifts. Compared to the baseline scenario, the Frozen rates scenario shows a more pronounced decline in male employment and a stagnation in female employment. In the Melting pot scenario, both male and female employment rates increase relative to the baseline, reflecting stronger integration policies. Differences in total hours worked across scenarios are even more pronounced. In the Melting pot scenario, growth in total hours worked is projected to exceed that in the baseline by 12% and that in the Frozen rates scenario by roughly one-third. This reflects not only higher employment rates but also structural differences in work patterns between population groups, and particularly the lower average weekly hours worked by employed Haredi men. In the baseline and the Frozen rates scenarios, hours worked per worker in the Haredi population are assumed to remain subdued. In the economic Melting pot scenario, a gradual increase towards the NHJO’s levels is assumed (see Annex 1.A).

Unsurprisingly, the QALI index, which adjusts labour input for hours worked and skill levels, rises more modestly than raw labour inputs in all three economic integration scenarios. This is due to the lower skills in the population groups experiencing faster growth. The difference is more significant in the case of faster integration (Melting pot) with more Haredim and Israeli Arabs joining the labour market. However, this effect is somewhat muted due to the assumption that the productivity gaps between populations will decline by 50% by 2065. In case of no convergence in productivity (a scenario that does not appear in the table), the QALI index in the melting point scenario would have increased by only 84%.

Table 1.5. Macro developments under different integration scenarios

Indicator	Baseline	Frozen rates	Melting pot
Women's prime-age employment rate (%), p.p change 2025 to 2065	+5.1	-0.5	+7.5
Men's prime-age employment rate (%), p.p change 2025 to 2065	-4.9	-5.0	+2.3
Total employment, 2065	8,511,603	7,898,076	9,015,874
Employment rate (15+), 2065, (%) (in 2025, 62.4)	63.1	58.5	66.8
Total hours worked, % change 2025 to 2065	+76	+68	+92
Quality-adjusted labour input (index), % change 2025 to 2065	+72	+65	+86
Potential GDP growth (%), 2025-2065 average	+2.95	+2.85	+3.15
Potential GDP growth per capita (%), 2025-2065 average	+1.64	+1.55	+1.84
Labour productivity per person employed growth (%), 2025-2065 average	1.40	1.45	1.45

Note: The decline in employment rates in the Frozen rates scenario primarily reflects changes in the age structure and demographic composition of the population.

Source: OECD calculations.

Figure 1.17 illustrates the expected GDP per capita trajectories for the outlined scenarios. By 2065, GDP per capita is projected to be 8% higher in the Melting pot scenario than in the baseline and 12% higher than in the Frozen rates scenario. Faster labour market integration could help Israel close a substantial share of its income gap vis-à-vis the OECD's leading countries. In particular, the Melting pot scenario could place Israel on a stronger convergence path, enabling it to elevate eight positions in the OECD ranking of GDP per capita by 2065, at a time when many of these countries are confronting shrinking working-age populations (Figure 1.18).

Disentangling the Melting pot scenario further according to the contributions of the population groups, the integration of the Haredim (Melting pot – only Haredim) is expected to raise GDP per capita by almost 6% compared to the baseline, while faster integration of the Arab population (Melting pot – only Arabs) is expected to contribute only 2.5%. This stronger effect in case of faster integration of the Haredim is due to three main reasons: the significant increase in the share of Haredim in the projected working-age population, a significant increase in working hours of Haredi men in the Melting pot scenario relative to the baseline, and the more positive recent developments regarding women's participation rates among the Arab population that are already considered in the baseline.

Figure 1.17. By 2065, GDP per capita is 8% higher in the Melting pot scenario than in the baseline and 12% higher than in the Frozen rates scenario

Projected GDP per capita index (2025=100) under different integration scenarios, constant prices

Source: OECD calculations.

Figure 1.18. Faster labour market integration could help Israel catch up to OECD leaders

GDP per capita as % of the US, Israel scenarios and projected figures for OECD countries based on the LTM

Note: The figures are presented in constant PPPs. ISR-B refers to the baseline scenario, ISR-F to the Frozen rates scenario and ISR-M to the Melting pot scenario.

Source: OECD calculations.

Table 1.6 illustrates the sensitivity of results to the demographic projections. As fertility in the baseline is assumed to follow the CBS low variant, GDP per capita in the Lower population growth scenario is closely aligned with the baseline. The gap represents a lower assumed life expectancy in the Lower population growth scenario, which increases the old-age population's share and reduces the active population's share. In the case of higher fertility (the Higher population growth scenario), annual potential GDP growth is expected to be about 0.1 percentage points higher on average than in the baseline in 2065. However, due to the higher total population, especially more minors, average annual GDP per capita growth is expected to be 0.3 percentage points lower than in the baseline. In a policy scenario that assumes the retirement age to increase beyond currently legislated changes (not presented in the chart), average annual GDP per capita growth is expected to be 0.04 percentage points higher than in the baseline (Figure 1.19).

Table 1.6. Macro developments under different population and policy scenarios

Indicator	Baseline	Higher population growth	Lower population growth	Ageing-related policy reforms
Women's prime-age employment rate (%), p.p change 2025 to 2065	+5.1	+5.1	+5.1	+5.1
Men's prime-age employment rate (%), p.p change 2025 to 2065	-4.9	-4.9	-4.9	-4.9
Total employment, 2065	8,511,603	8,976,378	7,904,909	8,678,317
Employment rate (15+), 2065, (%) (in 2025, 62.4)	63.1	62.2	63.7	64.1
Total hours worked, % change 2025 to 2065	76	90	64	78
Quality-adjusted labour input (index), % change 2025 to 2065	72	78	62	75
Potential GDP growth (%), 2025-2065 average	2.95	3.04	2.81	2.99
Potential GDP growth per capita (%), 2025-2065 average	1.64	1.32	1.65	1.70
Labour productivity per person employed growth (%), 2025-2065 average	1.40	1.34	1.42	1.39

Source: OECD calculations.

Figure 1.19. Higher fertility would reduce GDP per capita

Projected GDP per capita index (2025=100) under different demographic projections, constant prices

Source: OECD calculations.

1.4. Government spending on the horizon

Based on the demographic and economic assumptions described in the previous sections, this section presents a set of expenditure projections over the next 40 years. The starting point for these projections is the 2024 COFOG data uprated to 2025 for most spending vectors (Table 1.3 above). Despite the high uncertainty of any estimate reaching out 40 years into the future, these projections help plot a possible path for Israel’s public finances under current policy. The alternative scenarios presented later in this section illustrate the sensitivity of these projections to different underlying assumptions. This section highlights the main results, which are shown as a percentage of potential GDP to minimise the effect of the large output gap in 2025. A detailed description of the methods used to project each spending vector, as well as further results and reform analyses, is presented in Chapter 2 of this report.

1.4.1. The projected evolution of total outlays up to 2065

In the baseline, general government expenditures are expected to decline in 2026 before increasing over the following decade. This temporary rise reflects higher debt servicing costs resulting from rising interest rates, along with increased spending on transport infrastructure and public health. Thereafter, spending is projected to decline steadily due to the favourable population age structure and the gradual phase-out of past pension liabilities, reaching 37.5% of potential GDP by 2065 (Figure 1.20, Panel A). As illustrated in Panel B, this trajectory reflects the interplay of diverging expenditure trends. Upward fiscal pressures are expected primarily from rising interest payments – peaking around 2036 – and from increased health and old-age social protection expenditures paid by the NII, driven by population ageing. Together, these components are projected to raise total spending by 3.1% of potential GDP between 2025 and 2065. However, these increases are outweighed by projected declines in education spending, resulting from a drop in fertility, reductions in other social protection expenditures, primarily due to the phase-out of budgetary pensions and capital transfers to old defined benefit pension funds, and all other spending, accounting together for a decline of 5.7% of potential GDP by 2065. It follows that total annual spending will be 2.6 percentage points lower in 2065, with a different composition13. The share of civil expenditures (all except military expenditures and interest payments), which are low in international comparison, is projected to decline from 76% of total spending to 73% by 2065.

Figure 1.20. Total spending is projected to decline

Panel A: Total spending projection, compared to historic spending and the 2025 level (% of potential GDP)

 

Panel B: Contribution to spending changes (% of potential GDP)

Assumptions of baseline scenario: The baseline scenario considers a constant debt-to-GDP ratio of 66.3% (projected 2026 level), which is compensated by general government receipts. Results are shown as a percentage of potential GDP to minimise the effect of the large output gap in 2025. Demographic projections combine the CBS baseline and low population growth scenarios. Employment rates across different groups are assumed to converge in line with recent trends. Only legislated increases in the retirement age are taken into account. Allowances are projected to grow in line with historical trends rather than in accordance with legislated changes. An increase of one year in life expectancy is assumed to translate into 0.5 additional healthy years.

Source: Panel A) Actual data based on CBS data and projections based on OECD calculations. Panel B) OECD calculations.

Table 1.7. The composition of spending is projected to change significantly

Spending per COFOG category (% potential GDP)

	2025	2035	2045	2055	2065
1. General public services	5.1%	6.3%	6.5%	6.4%	6.1%
Within: Interest payments	3.3%	4.5%	4.8%	4.6%	4.5%
2. Defence	6.2%	5.8%	5.8%	5.8%	5.8%
3. Public order and safety	1.3%	1.3%	1.3%	1.2%	1.2%
4. Economic affairs	3.5%	3.8%	3.8%	3.8%	3.7%
Within: Transport	2.1%	2.4%	2.4%	2.4%	2.4%
5. Environment protection	0.5%	0.5%	0.5%	0.5%	0.5%
6. Housing and community amenities	0.0%	0.0%	0.0%	0.0%	-0.1%
7. Health	4.9%	5.1%	5.2%	5.3%	5.4%
8. Recreation, culture and religion	1.3%	1.3%	1.3%	1.3%	1.3%
Within: the sub-category including the Yeshivas	0.1%	0.1%	0.1%	0.2%	0.2%
9. Education	6.1%	5.8%	5.5%	5.1%	4.6%
Within: Pre-primary and primary education	2.8%	2.6%	2.4%	2.2%	1.9%
Within: Secondary education	1.4%	1.4%	1.3%	1.2%	1.1%
Within: Tertiary education	1.1%	1.1%	1.1%	1.0%	1.0%
10. Social protection	11.1%	10.3%	9.7%	9.2%	9.0%
Within: Sickness and disability (NII)	2.1%	2.0%	2.0%	1.9%	1.9%
Within: Old age (NII)	2.8%	2.9%	3.2%	3.5%	3.8%
Within: Family and Children (NII)	1.0%	0.9%	0.7%	0.6%	0.5%
Within: Old age (non-NII), mainly budgetary pensions, and subsidies to DB funds	2.0%	1.7%	1.1%	0.5%	0.3%
Total	40.1%	40.1%	39.5%	38.4%	37.5%

Note: Results are shown as a percentage of potential GDP to minimise the effect of the large output gap in 2025. The negative housing expenditure reflects government sales of housing assets and land, which are recorded as negative investment in COFOG. In 2024, land privatisation amounted to about NIS 20 billion (about 1% of GDP, similar to the last decade average). Going forward, land privatisation is assumed to remain constant as a share of GDP.

Source: OECD calculations.

1.4.2. The projected evolution of main spending categories up to 2065 in the baseline scenario

Assuming the teachers-to-students ratio will remain constant – implying stable class sizes and moderation in special education spending – and that teachers’ salaries will grow along with labour productivity in the total economy, education spending as a percentage of potential GDP is projected to decline from about 6.1% in 2025 to 4.6% in 2065, along with the projected decline in the share of children in the total population. The projected decline in spending is more significant in the pre-primary and primary levels, as the projected increase in the number of kids in the relevant age groups is more moderate. Relatively low expected fertility going forward (compared with past experience in Israel) will lead to a decline also in spending on early childhood education (reported in COFOG under Social Protection and General Public Services), even though an expected improvement in Arab women's labour participation would mean some upward pressure in specific communities. In contrast, expenditures on Yeshiva allowances (reported under Recreation, Culture and Religion Services) are expected to more than double. This increase is closely linked to the growing share of the Haredi population within the working-age population.

Public healthcare spending is projected to rise gradually, increasing from about 4.9% of potential GDP in 2025 to 5.2% by 2045 and 5.4% by 2065. In real terms, healthcare spending is expected to grow by an average of 6.9% annually. This upward trend is primarily driven by two factors: rising GDP per capita (reflecting income effects) and population ageing. Together, these account for roughly 80% of the projected increase. Additional upward pressure is expected from the Baumol effect – which assumes wage increases in health care in line with the broader economy despite slower productivity growth – and from the rising costs associated with technological advancements. However, these effects are largely offset by a degree of compression of morbidity, meaning people live longer in better health.

Social protection spending – the largest component of public expenditures in Israel – is projected to fall from 11.1% of potential GDP in 2025 to 9% by 2065. This overall trajectory masks important internal shifts. Two-thirds of social protection expenditures are channelled through the National Insurance Institute (NII), outside the central government budget. NII-administered spending is expected to rise modestly as a share of GDP, largely due to population ageing. However, this is partially offset by projected declines in spending on families and children, reflecting a shrinking share of children in the population and, to a lesser extent, reduced benefit generosity under current indexation rules. The remaining one-third of social protection expenditures not covered by the NII is mainly attributed to central and local government budgetary pensions and services for disabled people, alongside smaller expenditures. It is anticipated that these expenditures will decline by 2.3% of potential GDP, mainly as a result of the discontinuation of budgetary pensions and capital transfers to legacy defined benefit pension funds (Box 1.5) (Figure 1.21).

Figure 1.21. NII spending is projected to increase slightly, reflecting population ageing, while non-NII spending will decline sharply due to the phase out of budgetary pensions

Social protection spending (% of potential GDP)

Source: OECD calculations.

Box 1.5. Pension spending for public-sector employees is projected to fall dramatically

Budgetary pensions refer to unfunded, defined-benefit pensions paid directly from the government budget to former civil servants and public employees who entered service before 2002. Recipients include former central and local government employees, police officers, teachers in the state education system and certain other civil servant occupations (while conceptually similar, budgetary pensions for former career military personnel are recorded in the defence function under COFOG).

While new entries into the budgetary pension scheme ceased in the early 2000s, current eligible active workers are expected to continue retiring under the system through the 2030s. According to Israel’s Accountant General, annual payments in absolute terms will peak around 2040. However, since no new beneficiaries are entering the system, the relative expenditure as a percentage of GDP is already declining, having peaked at 2.2% in the last decade. Relying on the General Accountant projections in absolute terms and the GDP projection employed in this report, public spending is projected to fall from 1.4% of GDP in 2025 to about 0.9% in 2040 and to 0.1% by 2065.

Government spending on defined-contribution pension schemes for employees not covered by the budgetary scheme is not projected separately in this framework, as its effect should already be considered in wage growth dynamics and spending projections of the main vectors (health, education). In addition, they were anyway anticipated to peak around 2029 and remain steady (as a share of GDP) afterwards (Geva, 2015[3]).

Box 1.6. The expected change in the age composition and future public expenditures

Government spending in the future will depend on various factors, such as wage growth, the indexation of the NII’s allowances and the winding down of legacy expenditures. To demonstrate the effect of an ageing population, without considering other factors, displays government expenditures on health, education, and main NII allowances per capita by age group (Figure 1.22). Although education and child-related spending are predominant in early life, health and social security costs increase sharply with age. On average, spending on an individual aged 90 or above is almost seven times higher than on a 67-year-old. The figure also presents the current (2024) and projected (2065) age distribution of the population. Over time, demographic changes are expected to reduce the proportion of the population in low-cost age groups and substantially increase the share in older, high-cost groups, especially those aged 80 and above. This shift in demographics is likely to exert upward pressure on age-related public spending. Assuming a constant per-capita expenditure, the ageing population alone could lead to a 25% rise in government spending on health, education, and social safety nets.

Figure 1.22. Population ageing will put upward pressure on spending

Expenditures on health, education and welfare by age group and the age composition, 2024

Note: The chart provides a rough estimate of expenditures by age group based on the Israeli capitation formula (for health) and the recipiency rates of NII allowances by age (for social security spending). For education, the breakdown was according to the number of students by age. Expenditures on higher education were broken down by the number of students, categorised by age, in bachelor's degrees.

Source: OECD calculations.

In 2025, defence expenditures are expected to stand at 6.2% of potential GDP, about 1.5 percentage points higher than in 2022. However, some of these expenditures are temporary by nature. Considering the potential adverse effects of defence spending on civilian expenditures and potential growth, a public committee recommended increasing military spending to about 97 billion Shekels annually in 2026-2034 in 2024 prices (according to the MOF’s definitions for defence spending), with front-loaded investment following a relatively sharp decline in terms of potential GDP after 2028. In the baseline scenario, military spending is assumed to evolve according to these recommendations up to 2029. From that point forward, spending is assumed to remain constant as a share of GDP. Thus, defence outlays are not expected to generate additional fiscal pressures – either upward or downward – over the long term. Since security threats are not directly linked to population size, this assumption errs on the conservative side.

In light of the government's intensified initiatives to enhance transport infrastructure, encompassing the underground metro lines in the Tel Aviv Metropolitan area, it is assumed that expenditures on public transport and roadways will increase by about 0.3% of potential GDP by 2030, in accordance with pre-approved plans, and maintain elevated levels thereafter. This expected rise will position Israel among the OECD countries with the highest levels of public transport investment.

In the baseline, changes in other primary expenditures are anticipated to decrease by 0.5% of potential GDP. They are projected based on the assumption that governments will seek to provide a constant level of public spending per capita in real terms. Therefore, their evolution relative to GDP becomes a function of the projected population-to-employment ratio, as expenditure (numerator) is tied to population, whereas GDP (denominator) is tied to employment (Guillemette and Turner, 2017[20]). In the baseline, the population-to-employment ratio is projected to decline by 10% between 2025 and 2065, decreasing spending as a share of GDP. However, this excludes potential new sources of expenditure pressure, such as expenditures related to the energy transition and climate change adaptation.

Interest payments have risen sharply in recent years due to the spike in inflation and increases in interest rates, as well as large budget deficits. They are projected to increase further, as the implicit nominal interest rate paid on government debt represents a weighted average of the interest rates at which existing debt was issued in the past. Thus, it converges toward higher market rates only gradually as government debt is rolled over. Interest payments are projected to rise by 1.5% of potential GDP until reaching a peak in 2039, followed by a gradual decline afterwards as interest expenditures moderate due to a moderation in potential GDP growth and the debt-to-GDP ratio is assumed to remain steady.

Box 1.7. The outlook for the interest rate to growth rate differential (r – g)

Future trends in interest and GDP growth rates are crucial determinants of the future evolution of public debt ratios, as the simplified debt dynamics equation makes clear:

$∆d_t=(r_t-g_t){\bullet d}_{t-1}-{pb}_t$

where $d_t$is the debt-to-GDP ratio in year t, $r_t$is the implicit interest rate paid on government debt (annual interest expenditure on marketable and non-marketable debt divided by the total debt stock), $g_t$ is the nominal GDP growth rate and ${pb}_t$ is the primary fiscal balance. Any increase in the r – g differential puts upward pressure on the debt-to-GDP ratio and vice versa. Despite recent increases in market interest rates, the r – g differential is negative in almost all OECD countries, including Israel. This is largely because r is a weighted average of the interest rates at which existing debt was issued in the past. It converges toward market rates only gradually as government debt is rolled over. Meanwhile, nominal GDP growth has been robust in the post-COVID period.

However, in this model, the initially negative r – g differential is projected to turn positive after 2030 and reach 1.6 percentage points by 2065 (Figure 1.23). This development can be explained by three dynamics: (1) the short-term interest rate is assumed to converge towards the potential GDP growth rate as the output gap closes; (2) the long-term interest rate is projected to remain above potential GDP growth due to the normalisation of the currently negative term premium and a positive fiscal risk premium; and (3) the average debt maturity of 8.2 years is assumed to remain constant which causes a lag in the transmission of changes in the short-term interest rate to the implicit interest rate.

Figure 1.23. The r – g differential crucial to debt dynamics normalises in the baseline scenario

Source: OECD calculations.

1.4.3. Government spending under alternative scenarios

Given the significant uncertainty around these long-term projections, this section considers the spending implications of the five alternative scenarios described in Table 1.4: (1) two alternative labour market integration scenarios, (2) two alternative population growth scenarios, (3) and an ageing-related reform scenario.

Alternative labour market integration scenarios

Under the economic Melting pot scenario – which assumes faster convergence than in the baseline in employment rates, working hours and productivity – general government spending is projected to be lower by up to 0.8% of potential GDP by 2065 relative to the baseline (Figure 1.24). This reflects the long-term fiscal benefits of higher labour market participation (denominator effect). In contrast, the Frozen rates scenario, where employment rates across population groups do not converge, leads to a fiscal deterioration of approximately 1.1% of potential GDP by 2065 relative to the baseline. This scenario reflects the growing burden of demographic trends without further integration, including higher spending on religious services, lower employment propensities and labour productivity.

Figure 1.24. Labour market integration has significant spending effects

Projected general government spending, % of potential GDP, alternative labour market integration scenarios

Note: See Table 1.4 for the key macro assumptions of the scenarios.

Source: OECD calculations.

Alternative population projections

The results are also sensitive to population growth assumptions. Higher population growth leads to substantial increases in projected government spending, reaching a deviation of up to 2.2% of potential GDP by 2065 compared to the baseline. This increase is mainly driven by higher spending on education – due to a rise in the number of children – and ‘other’ primary expenditures as the employment-to-population ratio declines. Conversely, under the low population growth variant (in which the fertility assumption is similar to that in the baseline but life expectancy gains are more modest), government spending declines by 0.5% of potential GDP up to 2040, reflecting reduced pension and other old age expenditures due to shorter retirement periods (Figure 1.25). Due to fewer entries into the workforce and moderating potential GDP growth in the long term, the savings diminish over time so that spending is almost identical by 2065.

Figure 1.25. Education spending could add important cost pressures if fertility rates turn out higher

Deviation of spending from the baseline scenario (% of potential GDP)

Note: Lower and higher population data based on the original CBS 2019 population projections (low and median variant), rebased with 2022 actual data.

Source: OECD calculations.

Ageing-related policy reforms scenario

In the Ageing-related policy reforms scenario, the female statutory retirement age will gradually rise to match the male retirement age by 2040, rather than remaining constant at 65 years from 2032 as in the baseline scenario. Beyond 2040, both female and male retirement ages are indexed to gains in life expectancy at a rate of 2/3:1. At the same time, improvements in the efficiency of the healthcare system and investment in preventative health care are assumed to translate life expectancy gains into much healthier ageing, reducing the need for disability and long-term care benefits at a given age. This reform package generates fiscal savings of about 0.7% of potential GDP by 2065, slightly less than the Melting pot scenario. The savings are largely realised from 2032 onwards, when the retirement age begins to deviate from the baseline scenario. Spending reductions are driven by higher labour force participation among older adults (55+) and lower spending on social transfers and healthcare (Figure 1.26).

Figure 1.26. Raising the retirement ages could create significant fiscal space

Deviation of spending from the baseline scenario (% of potential GDP)

Note: The Policy reforms scenario assumes that the female statutory retirement age gradually rises to match the male retirement age by 2040. Beyond that year, both are indexed to gains in life expectancy at a rate of 2/3:1, reaching 68.5 by 2065. At the same time, improvements in the efficiency of the healthcare system and investment in preventative care are assumed to translate life expectancy gains into an additional 0.1 of healthy ageing on top of the baseline assumption of 0.5 (see Chapter 2, Section 2.2 for further explanations on the healthy ageing assumption).

Source: OECD calculations.

1.4.4. The impact on the main fiscal aggregates

Fiscal pressure indicator under a stable and a declining debt-to-GDP ratio path

This section presents the fiscal adjustments (additional revenues or spending cuts) needed to stabilise or reduce the debt-to-GDP ratio, given the spending pressures discussed above (see Box 1.8 on the construction of the fiscal pressure indicator). Total revenues (or spending cuts) required to stabilise the debt-to-GDP ratio at its projected 2026 level would, on average, be 0.4% of potential GDP higher than in 2026 until 2045, in line with projected trends in total outlays, before declining thereafter (Figure 1.27, blue line). Alternatively, if the government aims to reduce the debt level to 50% of GDP until 2045, following a linear path, and stabilise it from that point onwards, aligning with its long-term objectives revealed by Israel’s fiscal rules (see Box 1.1 above), annual revenues would need to increase, on average, by 1.1 percentage points above the 2026 level (green line). The sharp decline in 2046 reflects the attainment of this long-term target. Reducing the debt stock to 50% would lower interest expenditures and, consequently, the revenue required to maintain the debt ratio stable in the second half of the projection period relative to the baseline scenario. Unsurprisingly, in the case of faster labour market integration, stabilising or reducing the debt-to-GDP ratio would be easier. In the Melting pot scenario, total revenues would need to increase by 0.5% of potential GDP by 2036 (compared to 0.8% in the baseline) and could decline by 2.4% until 2065, relative to 2026.

Box 1.8. The fiscal pressure indicator

In the baseline, the model mechanically adjusts general government receipts as a share of potential GDP to ensure convergence of the gross debt-to-GDP ratio to its 2026 level, implying stability of this ratio over time. This needed adjustment is also called the fiscal pressure indicator. Changes in this fiscal pressure indicator are due to two factors: (1) an initial structural fiscal gap, reflecting any disequilibrium between the initial structural government balance and the one consistent with keeping the debt ratio stable, and (2) the projected changes in total public expenditures described above. The long-run fiscal adjustment is assumed to begin in 2027. Until 2026, general government revenues are derived from the most recent OECD Economic Outlook. No consideration is given to Keynesian effects on demand or the supply-side feedback resulting from increased or decreased taxation.

These estimations do not imply that taxes would or should change in the future. Future governments could also meet long-run fiscal challenges by cutting public expenditures, for instance, through efficiency improvements. Moreover, considerations missing from the framework, such as distributional issues, should also be considered in the decision-making process.

Figure 1.27. Stabilising debt as a share of GDP would require fiscal adjustments

General government receipts (% of potential GDP)

Note: The required receipts are determined as a function of the endogenous spending projections and the target debt-to-GDP path. The figure presents the required revenues, but fiscal pressures could also be addressed by changing public expenditures. The potential impact of higher/lower revenues on GDP is not considered.

Source: OECD calculations.

Evaluating fiscal sustainability risks by comparing fiscal pressures with those of other OECD countries

Fiscal pressures in Israel are expected to be small compared to most OECD and non-OECD peer countries. Figure 1.28 shows that, although government structural primary revenues are already higher in most other countries than in Israel, they will need to increase further to stabilise debt-to-GDP ratios at current levels. Israel, on the contrary, is one of only five countries where fiscal pressures are expected to ease between 2025 and 2060, allowing receipts to decline from 35.9 to 34.9%. Notably, not all countries expected to gain fiscal space in the coming decade benefit from a demographic dividend like Israel, highlighting the potential impact of fiscal and structural reforms.

Figure 1.28. Future fiscal pressures are low compared to other OECD countries

Structural primary revenue (% of potential GDP)

Note: The chart shows how the ratio of structural primary revenue to potential GDP would need to evolve between 2025 and 2060 in order to keep the gross debt-to-GDP ratio broadly stable at its current level over the projection period. Fiscal pressures could also be addressed by changing public expenditures. The projection approach for Israel differs from that of peer countries, as the OECD long-term model has been adapted to account for the effects of Israel’s specific demographic trends on employment and labour quality, as well as idiosyncratic fiscal pressures.

Source: OECD (2025[26]) and OECD calculations.

Debt evolution assuming unchanged revenues

Thus far, a key assumption has been that general government receipts would adjust over time to stabilise the debt-to-GDP ratio at its 2026 level throughout the projection period. An alternative approach is to illustrate the evolution of the debt-to-GDP ratio under the assumption of stable revenues. In this approach, structural primary revenue as a share of GDP is assumed to remain constant at the level projected in the latest Economic Outlook while interest spending evolves according to its endogenous path. Then, government debt becomes the shock absorber.

Assuming general government receipts remain unchanged, the debt-to-GDP ratio would rise to about 77% by 2048 as high annual deficits accumulate and raise debt servicing costs (Figure 1.29). Higher marginal borrowing costs, reflecting a higher risk premium, would further intensify this adverse dynamic. As a result, interest expenditures as a share of potential GDP could remain more than one percentage point above 2025 levels until the end of the projection period. Nonetheless, due to the accelerating decline in primary spending from 2040 onwards, driven by favourable demographics and the phasing out of budgetary pensions, the debt-to-GDP ratio would stabilise and even decline somewhat at the end of the projection period, even without further reforms.

Nevertheless, structural policy reforms could curb the rise in public debt much earlier and reverse the trend, thereby limiting the increase in interest payments and creating greater fiscal space for more growth-enhancing expenditures. One option would be to increase government receipts, ideally, by phasing out numerous tax exemptions (OECD, 2025[8]). Another approach would be to raise the retirement age and implement measures to compress morbidity, as outlined in the Policy Reforms scenario, while also accelerating labour market reforms to better integrate population groups, which are necessary for the realisation of the Melting pot scenario. These measures would provide a favourable boost to GDP and reduce primary spending on transfers. In a scenario of combined reforms, the debt-to-GDP ratio would peak already in the early 2040s and then decline to a low level, even without modifying taxation. In contrast, if necessary medium-term fiscal adjustments do not occur and spending on special education, long-term care, and disability benefits continues to rise rapidly, as it has in recent years, the debt-to-GDP ratio would increase more rapidly and continue to rise throughout the projection period, risking crowding out private investment, raising inflation expectations, and limiting the ability to use countercyclical fiscal policy. For a detailed explanation of these risks, see Chapter 2 of the report.

Figure 1.29. Israel’s long-term debt path under alternative scenarios

Debt-to-GDP ratio if general government receipts remain constant as % of potential GDP at the 2026 level

Note: In all scenarios, general government receipts are assumed to remain constant at 36.1% relative to potential GDP (2026 level). The combined Melting pot and Ageing-related policy reforms scenarios are a simple combination of the scenarios described in Table 1.4 above. The Adverse fiscal path assumes that (1) spending on special education will increase by 30% more than other education spending until 2035; (2) higher prices for LTC would not diminish demand (price elasticity of 0); (3) LTC recipiency rates would remain unaffected by healthy ageing; (4) recipiency rates for disability allowances will rise by about 12% by 2035, rising also NII spending on work injuries; and (5) that the number of disabled children will rise even more rapidly until 2030, reflecting stronger momentum. These upward fiscal pressures are assumed not to influence GDP growth.

Source: OECD calculations.

1.4.5. From projecting general government expenditures to budgetary spending

The above projections focus on general government expenditures. Nonetheless, in Israel, the legally mandated expenditure ceiling (Box 1.1) applies to central government spending and excludes certain spending funded by earmarked revenues and expenditures of other public institutions. Expenditures included under the ceiling comprise, among others, central government transfers to the National Insurance Institute, government-funded portions of health expenditures, interest payments on public debt and transfers between the government and public institutions such as the National Insurance Fund. Expenditures excluded from the ceiling include those financed by earmarked payroll taxes (e.g. the health tax and social security contributions), local government expenditures (except for central government transfers), government debt indexation costs, and spending by semi-autonomous public bodies such as governmental hospitals and the Israel Land Authority. The distinction between spending included in and excluded from the budget ceiling is important for the Ministry of Finance's expenditure planning and for encouraging fiscal responsibility of semi-governmental bodies. Still, fiscal imbalances in excluded entities could generate implicit liabilities for the central government, underscoring the importance of monitoring spending beyond the ceiling (i.e. general government spending).

Spending under the budget ceiling is modelled by considering only budgetary items and their classification into COFOG functions, as described in Table 1.3 above. In general, these expenditures are uprated using the detailed projections by 2-digit COFOG function, consistent with the projections for general government expenditures. The underlying assumption is that spending under the budget ceiling will broadly follow the same trajectory as that within the corresponding COFOG category. A more granular approach is applied to health, social protection and interest spending (Box 1.9).

Table 1.8 shows the composition of spending under the budget ceiling and general government spending. The differences in composition reflect, among other factors, the higher interest payments of the central government, mainly due to transfers from the central government to the NII, which are consolidated in general government spending, and the central government’s reduced exposure to health and social protection expenditures.

Table 1.8. The share of civil expenditures under the budget ceiling is lower

Share of total spending in the respective period under the budget ceiling (of the general government), %

Spending category	2025	2045	2065
Interest payments and other debt transactions	12.1 (8.2)	14.9 (12.0)	14.7 (11.9)
Health	10.1 (12.2)	10.4 (13.1)	11.6 (14.5)
Education	17.1 (15.2)	15.1 (13.9)	13.2 (12.2)
Social protection	20.7 (27.7)	21.2 (24.5)	20.8 (24.0)
All others	40.0 (36.7)	38.3 (36.5)	39.7 (37.5)

Source: OECD calculations.

The differences between the trends of general government annual spending and spending under the budget ceiling are relatively modest. The lower exposure to health and social protection expenditures covered by the NII – two functions that grow faster than GDP – results in a slightly steeper decline of spending that falls under the budget ceiling. However, the projected depletion of the NII fund in 2037 in the absence of reforms (Figure 1.30, Panel A) would cause a sharp, one-off increase in spending under the budget ceiling in the same year (Panel B). For a detailed explanation of the NII Fund projection, see Sub-section 2.4.10 on contingent liabilities in the social protection system in Chapter 2.

The depletion of the NII Fund is expected to have two main effects on spending under the budget ceiling. First, the Ministry of Finance will no longer need to pay interest and make capital transfers to the NII (with implications on the revenues side, as well). Second, as the NII loses its interest income and immediately records higher deficits that the Fund can no longer absorb, the liability for the government is realised. It follows that the NII deficit will fully fall under the budget ceiling as social protection spending.

Figure 1.30. Spending under the budget ceiling will grow slower, with a sharp one-off increase expected upon NII fund depletion

A) National Insurance Fund volume (left axis) and NII balance (right axis), % of potential GDP

 

B) Expenditures as a % of potential GDP, Index (100=2026)

Source: OECD calculations.

Box 1.9. Method used to evaluate health, social protection and interest spending under the budget ceiling

For health, the projected additional general government expenditure (as a share of GDP) is fully included under the budget ceiling. This reflects the assumptions that revenues from the health tax will grow in line with GDP, and that there will be no change in the deficits of national health institutions.

Social protection expenditures under the budget ceiling include transfers to the National Insurance Institute (NII). The central government contributes to NII income in three ways. First, it partially compensates the NII for its expenditures, with the allocation depending on payroll tax revenues. Second, it reimburses NII expenditures under Article 9 of the National Insurance Law, including, for example, means-tested income supplements and payments to victims of terror attacks. Third, it pays interest on the National Insurance Fund, which the NII lends to the Ministry of Finance. This last channel falls under Public Debt Transaction (COFOG 1.7) rather than Social Protection (COFOG 10).

To reflect the latest change to the NII’s law, the compensation based on the payroll tax (Article 32) is assumed to increase gradually up to 2030 and remain constant afterwards. For the same reason, the NII’s revenues from the payroll tax are assumed to decline in 2027 due to the expiration of the temporary increase in the payroll tax rates. These two measures, in principle, are offsetting each other. Beyond that, payroll tax revenues are assumed to grow in line with GDP (as for the health tax).

Additional compensation for allowances not covered by the National Insurance Law (Article 9) is projected using detailed expenditure projections for specific items, including income supplements to old-age pensions and survivors’ pensions. Smaller expenditure items (e.g. the movement allowance under COFOG 10.1 Sickness and Disability) are assumed to grow at the same rate as other NII spending within the same 2-digit COFOG category. A small residual between compensation and expenditures under Article 9, covering administrative costs, is assumed to grow in line with GDP.

Interest payments under the budget ceiling do not only include the cost of financing government debt in capital markets and pension funds, but also the capital transfers from the Ministry of Finance to the NII (both debt redeemed and interest on outstanding debt). The latter are projected based on a simulation of the National Insurance Fund and the NII deficit (see more details below), for which a few simplifying assumptions are made. Debt redeemed and rolled over in any given year is assumed to be constant as a share of the remaining fund volume. Bonds issued by the Ministry of Finance and held by the NII are assumed to consist of 50% fixed-yield bonds (with a real coupon of 5.5%) and 50% marketable bonds with a constant maturity of 18 years throughout the projection period. The marginal borrowing costs of the latter follow the projected yield curve (see Chapter 2 of the report), and the effective borrowing cost for these bonds is approximated using the starting implicit interest rate and the annual change in average borrowing costs due to rollover.

In contrast to the method used for projecting general government spending, expenditures related to the indexation of government CPI-linked debt paid upon maturity are excluded from interest payments under the ceiling as they are recorded as debt redemption in the budget.

Source: OECD elaborations.

1.5. Safeguarding fiscal sustainability and further improving the long-term projections

This report presents projections for public expenditures over the next 40 years based on different assumptions about population growth, the labour market integration of various population groups, and policy reforms. In the baseline scenario, which assumes current labour market trends to continue, fiscal pressures rise moderately until around 2040 before easing thereafter. It puts Israel’s public finance in a low-risk zone in a widely used indicator of fiscal sustainability. Israel is one of only five countries where fiscal pressures are expected to ease between 2025 and 2060, allowing receipts to decline slightly to keep the debt-to-GDP ratio constant.

Despite the positive outlook, several risks remain. First, elevated geopolitical risk means more substantial buffers against shocks are needed. Second, unless steps are taken to close the structural fiscal deficit and contain medium-term spending pressures, particularly those stemming from higher interest payments, Israel’s indebtedness could rise substantially. Assuming unchanged revenues and spending policies, the debt-to-GDP ratio could rise to 77% within the next two decades. Third, long-term projections such as these are always highly uncertain. If spending on special education, long-term care, and disability benefits continues to rise rapidly, as it has in recent years, the debt-to-GDP ratio would increase more rapidly. Likewise, the war and its consequences require a considerable increase in government spending. It remains uncertain whether these needs will be primarily one-off or structural in nature. Finally, Israel’s core infrastructure stock lags significantly behind other OECD countries, which could hamper long-term productivity growth. Insufficiently developed physical and digital infrastructure could exacerbate congestion and limit high-tech expansion. Closing the public-capital-stock gap with the OECD average would require a permanent increase in public investment (OECD, 2025[8]). Currently, a permanent increase in spending on transport infrastructure of about ¼ of GDP is factored into the baseline scenario. Even higher spending might be needed if Israel aims to close the infrastructure gap more rapidly.

Reforms to boost potential growth and make public expenditures more efficient could help mitigate these risks. The first two sections of this chapter provide an overview of some of these reforms, drawing on the recommendations provided in the OECD Economic Surveys of Israel.

1.5.1. Reforms to accelerate labour market integration and unleash potential growth

As described in previous OECD Economic Surveys for Israel and illustrated by the gap between the projected output under the Melting pot scenario and the Frozen rates scenario, long-term economic performance and standard of living will depend heavily on reforms that improve educational outcomes and labour market participation among Haredim and Arab Israelis. Without such reforms, male employment rates are projected to decline, dragging down potential GDP growth. A recent publication by the Ministry of Finance indicates that demographic shifts are already weighing on labour supply (Geva, 2025[34]). Over the past decade, participation among young men (ages 15–34) in either education or the labour market has fallen, driven by a growing share of Haredim and Arab Israelis in this age group, alongside persistently low and declining engagement in education and employment14. Table 1.9 presents key recommendations for enhancing labour market integration from the last two OECD Economic Surveys (2023 and 2025).

For countries like Israel, which still have a considerable gap vis-à-vis the United States regarding labour productivity and GDP per capita, projected long-term economic growth is also highly affected by the speed of convergence, modelled as a function of a country’s framework conditions. These include the quality of governance, the degree of economic integration in global markets and macroeconomic stability. For Israel, the convergence speed associated with these conditions is relatively low, mainly due to the lower quality of governance as proxied by the World Bank’s Rule of Law indicator. Judicial independence and democratic checks and balances will therefore be vital to attract investment and maintain high economic growth (OECD, 2023[1]).

Table 1.9. OECD past recommendations to foster long-term growth

CHALLENGE	RECOMMENDATION
Several specific benefits and exemptions for Haredi men discourage and delay their labour force participation.	Remove government subsidies for yeshiva students and condition childcare support on fathers’ and mothers’ employment.
The gender employment gap is highest among Arab-Israelis.	Increase the provision of accredited childcare in Arab municipalities.
Coverage of the core curriculum is incomplete in ultra-orthodox streams, impairing pupils’ employment and wage prospects. Resource allocation is unequal across schooling systems.	Condition school funding on full teaching of the core curriculum while ensuring equal per-pupil funding for schools with equal socio-economic characteristics.

1.5.2. Enhancing efficiency in public expenditures

Israel should pursue enhancing the efficiency of the public sector to leave room in the budget to increase underfunded civil expenditures, especially on transport infrastructure, and reduce medium-term fiscal pressures. It should carefully monitor expenditures related to special education, disability benefits, and long-term care – all of which have increased dramatically in the last few years from already high levels – and ensure these expenditures are aligned with the government's long-term targets. While in the baseline scenario, the speed of the increase in spending on these categories is expected to moderate in the coming years, there is high uncertainty around the assumptions influencing these results. If spending on special education, long-term care and disability benefits continues to grow at the rapid pace observed in recent years, the debt-to-GDP ratio would not stabilise over the projection period and could reach around 100% by 2050. Conducting a spending review in the upcoming budget cycle, focusing on these expenditure items, could help make these expenditures more targeted and efficient.

Additionally, Israel should gradually align the retirement age of women to that of men. It is one of only six OECD countries where the future normal retirement age is lower for women than for men, alongside Colombia, Costa Rica, Hungary, Poland and Türkiye (Figure 1.31) (OECD, 2023[35]). Thereafter, it should link the future statutory retirement age to changes in life expectancy. In such a scenario, GDP per capita is expected to be 1.5% higher than in the baseline by 2065, and total spending as a share of potential GDP 0.7% lower. One in four OECD countries now links retirement ages to life expectancy, including Denmark, Estonia, Finland, Greece, Italy, the Netherlands, Portugal, the Slovak Republic and Sweden. Such links limit the political cost of undertaking unpopular measures such as raising the retirement age (Box 1.10).

To contain fiscal pressures from rising healthcare costs and to promote healthy ageing, Israel should ensure adequate numbers of healthcare workers and invest more in preventive health technologies. As noted in the 2023 OECD Economic Survey, the number of domestically trained physicians is insufficient to meet the demands of a rapidly growing and ageing population, particularly in the northern and southern regions. Consequently, wages in the health sector are higher than in most OECD countries and are rising rapidly. Expanding medical school capacity, as planned, and ensuring strong enough incentives for newly trained doctors to work in underserved areas are keys to improving access and alleviating wage pressures. In parallel, prioritising investment in preventive and digital health technologies (at the expense of compared therapeutic technologies) can help delay the onset of chronic diseases, thereby reducing long-term care costs whilst increasing the labour market participation of older people. This would support a model of “healthy ageing”, ensuring that the ease of spending pressures already assumed in the baseline scenario materialise. These measures, combined with regular updates to payment and reimbursement systems to better reflect service costs, could enhance efficiency, reduce wait times, and ensure a fiscally sustainable health system over the long run (OECD, 2023[1]).

Figure 1.31. Israel is one of only six OECD countries with a lower normal retirement age for women

Deviation of the current and future retirement ages for a woman with a full career starting at age 22 from men.

Source: OECD Pensions at a Glance 2023.

Box 1.10. Links of retirement age to life expectancy in OECD countries

One in four OECD countries now links retirement ages to life expectancy, including Denmark, Estonia, Finland, Greece, Italy, the Netherlands, Portugal, the Slovak Republic and Sweden. Beyond pensions, such links lower the impact of ageing on total output and, ultimately, on the average standard of living of the whole population. Two aspects make the implementation of such a link attractive. First, it is conditional on health changes effectively taking place, as captured by life expectancy. If health improvements do not materialise, then retirement ages do not increase. Second, such links limit the political cost of undertaking unpopular measures such as raising the retirement age.

The exact link differs across countries. Denmark, Estonia, Greece, Italy and the Slovak Republic increase the retirement age by one month for every month gained in life expectancy at age 65, except for Denmark, which uses age 60. This might be needed to ensure financial sustainability in these countries. Still, a one-to-one link implies that all additional expected life years are spent working while the length of the retirement period is constant, leading to a steady decline in the share of adult lives spent in retirement. In Denmark, the parliament has to vote every five years to ensure the link is maintained.

In Finland, the Netherlands, Portugal and Sweden, the statutory retirement age increases by two-thirds of the change in life expectancy at 65. These links are designed to maintain a roughly constant ratio of expected time in retirement to time spent working. Additionally, in Portugal, individuals with more than 40 years of contributions can retire four months earlier each year, provided they have made at least 40 years of contributions. This effectively implies that only half of the life expectancy gains are reflected in the normal retirement age. The Netherlands switched from a one-on-one to a two-thirds link before it took effect in 2020, and discussions in Denmark are ongoing on whether to move from a one-to-one to a slower link. Hence, while a one-to-one link may be beneficial from a financial sustainability perspective, the political sustainability of such a link might be weak over time.

Source: OECD Pensions at a Glance 2021 (OECD, 2021[36]).

1.5.3. Further improving the long-term fiscal projections

Several improvements should be pursued to enhance the usefulness and reliability of the long-term public expenditure model and improve Israel’s fiscal institutions. First, the Ministry of Finance would benefit from closer collaboration with the Central Bureau of Statistics (CBS) to ensure that demographic projections are updated more frequently, so the fiscal model could reflect the most recent trends in fertility, migration, and life expectancy. These projections are a cornerstone of long-term fiscal modelling, particularly in health, pensions, and education. In many OECD countries (the United Kingdom, Germany and the Netherlands, for example), statistical offices revise their population projections every two or three years, allowing fiscal models to capture shifts in demographic dynamics better. In contrast, Israel’s demographic projections are updated less frequently, which can introduce outdated assumptions into long-term fiscal planning.

Second, while the current model focuses on expenditures, developing a parallel framework for long-term revenue projections is desirable. Many long-term fiscal projections use the standard assumption that tax revenues grow commensurately with nominal GDP growth or calculate the required revenues to stabilise the debt ratio (as in this report). However, some tax bases may have dynamics that differ significantly from those of the economy itself. For example, excise taxes – which are high in Israel – could decline in case they are found to be effective in reducing consumption. Likewise, demographic changes can also impact government revenues (Box 1.11) (Box 1.12). Finally, the Ministry of Finance should encourage more applied research on structural factors that influence long-term expenditures, such as the economic and fiscal implications of healthy ageing and technology adoption in public services.

Box 1.11. The UK Office for Budget Responsibility's approach to projecting government revenues

The UK Office for Budget Responsibility (OBR) publishes long-term projections of government revenues in its Fiscal Risks and Sustainability Report. Projections are based on age-adjusted, per-person receipts, applying tax profiles by age and sex to population projections from the Office for National Statistics (ONS). In specific areas where policy is expected to significantly affect receipts – notably fuel duty (due to the shift to electric vehicles) and tobacco duty (due to public health measures) – the OBR uses bespoke modelling that accounts for expected changes in demand. Oil and gas revenues are projected separately, based on assumptions about future output, prices and profitability.

This method captures both the indirect impact of ageing, which can slow employment, earnings and consumption growth, and the direct impact on the receipts-to-GDP ratio. In the UK context, and holding other factors constant, an ageing population may be expected to raise the receipts-to-GDP ratio modestly over time. This reflects that older groups typically continue to pay income tax (on pensions and savings), VAT, capital taxes and council tax, even though they contribute relatively less to measured economic output.

Source: Fiscal Risks and Sustainability Report – Office for Budget Responsibility (2024[37]).

Box 1.12. Applying National Transfer Accounts to assess the impact of the age structure on future tax revenues

The National Transfer Accounts (NTA) project (led by the UN) provides data on financial flows in National Accounts by age for over 50 countries, enabling the estimation of how different age groups contribute to and benefit from the public sector and, therefore, assessing how demographic changes may impact tax receipts and public spending. In a static approach, age-specific profiles are held constant over time, so changes in tax revenues and expenditures arise solely from shifts in population age structure. While this provides useful stylised insights into the composition effects of ageing, this method does not account for behavioural or policy changes, as well as expected changes in the macroeconomic variables.

For Israel, detailed NTA profiles were recently calculated by the Taub Center for Social Policy Studies (Shraberman and Weinreb, 2024[38]). Their work disaggregated Israel’s NTA schedule into three major subpopulations (NHJO, Arab, and Haredim) and linked these to national fiscal indicators. Their findings, based on 2018 data, show that tax receipts per capita peak between ages 40 and 60, driven largely by labour income taxes, social contributions, and corporate taxes. Younger individuals mainly contribute through consumption taxes, while older individuals continue to contribute modestly via taxes on pensions, savings, and consumption.

Figure 1.32. Assuming current recipients per capita, the average individual could be expected to pay higher taxes

Tax per capita by age (NIS), 2018

Source: Shraberman & Weinreb (2024[38]), “The fiscal consequences of changing demographic composition: Ageing and differential growth across Israel’s three major subpopulations”.

Building on these results, a simple simulation was conducted. By assuming the 2018 age-specific tax profiles remained unchanged until 2022 and applying the mixed variant population projection used in the baseline scenario up to 2065, the simulation showed that the tax receipts could increase by about 6.8% by 2065 solely due to changes in the age composition (about two percentage points of GDP). This reflects population ageing, which in Israel will result in a larger proportion of people falling into age groups that traditionally pay more taxes (see the above chart).

Sources: Shraberman & Weinreb (2024[38]), “The fiscal consequences of changing demographic composition: Ageing and differential growth across Israel’s three major subpopulations”, The Journal of the Economics of Ageing; Sicsic & Perret (forthcoming), “Assessing the vulnerability of tax revenue to ageing in OECD countries”.

To encourage a long-term perspective in policy discussions, the model should become a tool regularly updated and published by the Ministry of Finance. The experience in other OECD countries shows the value of long-term projections in informing debates about fiscal priorities, intergenerational equity, and structural reforms. Regular public discussion and parliamentary engagement with the model’s findings can help build consensus on long-term fiscal planning and ensure that current policy choices are consistent with fiscal realities. Likewise, sustainability indicators should be communicated externally in an easy-to-understand fashion, and changes from previous publications should be explained, as in the Ministry of Finance’s Numerator publication (see below). A good example is the Slovak CBR's publications that follow the developments in the sustainability indicators and breakdown changes in the leading indicator attributed to changes in policy or assumptions (Figure 1.33).

Figure 1.33. Tracking the long-term sustainability indicator over time

The evolution of the sustainability indicator in Slovakia as monitored by the Slovak CBR

Note: One of the main tasks of the Slovak Council for Budget Responsibility (“CBR”) laid down in the Fiscal Responsibility Act is to publish a report on the Long-term Sustainability of Public Finances. The report evaluates whether public policies, in conjunction with the assumed demographic and macroeconomic development, have been set up in a sustainable manner from the perspective of public finances. The long-term sustainability of public finances is considered to have been achieved if the long-term sustainability indicator is in the low-risk zone, i.e. less than 1% of GDP. The long-term indicator measures the immediate and permanent fiscal adjustment, either through increased revenues or decreased expenditures, required to ensure that public debt remains below the constitutional debt limit over a 50-year horizon.

Source: The Slovak Council for Budget Responsibility (2024[39]).

Policy discussions could also benefit from more transparency about the medium-term expenditure trajectory and its relation to long-term trends. The Ministry of Finance publishes projections for only six broad spending aggregates (defence and social order, social expenditures, investment in infrastructures, interest payments, government headquarters, and other expenditures) as part of its Medium-Term Budgetary Plan (the Numerator), published twice a year to inform fiscal developments. Further breaking down these projections, combining them with the National Insurance Institute forecast, and presenting the data according to COFOG definitions could provide a better and more timely understanding of fiscal pressures. Further breakdown of expenditures would also enable reliance on the Medium-Term Budget Plan as a starting point for long-term projections, enhancing the linkage between publications. Relying more heavily on the COFOG data would also ease cross-country comparisons, a strong analytic tool for a small open economy like Israel.

1.5.4. Informing the design of the fiscal rules through the long-term projections

Israel would also benefit from reviewing its fiscal rules (Box 1.1 above), as recommended in the 2023 Economic Survey, aiming to strengthen their effectiveness (OECD, 2023[1]). The deficit and expenditure ceilings have been revised frequently since their introduction, compromising their ability to guide fiscal policy. The spending projections presented in this report also highlight the restrictive nature of Israel’s expenditure ceiling. Despite a projected annual decline in government expenditures under the budget ceiling of 1.2 per cent relative to potential GDP by 2065 (2.6 per cent for general government expenditures), the expenditure growth cap set by the fiscal rule would require a stricter path. Real expenditure growth would need to be about 0.7 percentage points lower each year (Figure 1.34), resulting in an accumulated 25 per cent fiscal consolidation by 2065 relative to the baseline scenario. This would require surplus consolidation that is probably neither realistic nor desirable.

Anchoring the rule in credible long-term scenarios could enhance trust in the fiscal rules. The projections’ results can assist in that regard. They can inform about the needed adjustments in expenditures to reach a medium-term target that ensures that the debt-to-GDP ratio is sufficiently diminishing, which is also the main goal of the current set of fiscal rules. Under the new EU rules, for example, countries must ensure that their projected general government debt ratio is put on a plausible downward path or stays at prudent levels below 60% of GDP as a result of a medium-term expenditure path of four to seven years (“Medium-Term Fiscal Structural Plans”) (Regulation (EU) 2024/1263). ‘Plausibly downward’ means that there is at least a 70% probability that debt will decline, based on a stochastic Debt Sustainability Analysis (Darvas, Welslau and Zettelmeyer, 2024[40]).

A potential issue with the current expenditure ceiling is that, by focusing solely on population growth and the debt-to-GDP ratio, it does not account for fiscal space generated by stronger economic growth, for example, through productivity gains or higher employment rates. Similarly, it does not take into account the economy’s position in the business cycle, which limits (if used as an effective anchor) the government's ability to minimise economic shocks. Box 1.13 presents expenditure ceilings used in other OECD countries.

Figure 1.34. The projected decline in spending would be insufficient to meet Israel’s expenditure growth rule

Annual projected expenditure growth of spending included under the budget ceiling, in real terms, and the real component of the expenditure growth rule

Note: The expenditure growth paths assume that debt-to-GDP remains constant from 2026 onwards. Population growth rates informing the expenditure ceiling (expenditure growth cap) are aligned with the mixed variant of the baseline scenario. The sharp increase in spending growth in 2036 and 2037 reflects the reallocation of spending under the budget ceiling following the depletion of the NII (see Figure 1.30 above).

Source: OECD calculations.

Box 1.13. Expenditure ceilings in selected OECD countries

By capping the outlays directly under government control, expenditure ceilings tackle the problem of the government’s tendency to overspend in good times. Unlike balance rules that rely on revenue forecasts or structural estimates, spending limits are more transparent and easier to monitor, anchoring budget decisions in concrete terms.

Nonetheless, such ceilings must be carefully crafted to avoid unintended effects. If set too rigidly or without regard to composition, they might squeeze high-priority investments or prompt governments to resort to off-budget tricks (e.g. tax expenditures) to achieve targets. A strong public investment framework (which doesn’t exist in Israel) and smoothing spending on infrastructure over longer periods can help minimise the possible effect of fiscal rules on public investment. Likewise, expenditure ceilings should align with the government’s overall debt and deficit objectives for comprehensive control. Emergency clauses or special budgets should be permitted for major shocks, but only under clear criteria and perhaps with correction mechanisms. Strong and independent fiscal institutions could add transparency and help resist political pressure to loosen rules based on overly optimistic projections. Israel’s Ministry of Finance's efforts to tighten the process of outlining the economic forecasts that underpin the budget, including the creation of a dedicated team within the Chief Economist’s Department and the establishment of clear procedures for conducting and publishing these forecasts, serve as a good and recent example for enhancing such institutions.

The Netherlands has operated an expenditure rule since the mid-1990s, anchored in real-term multi-year ceilings agreed in coalition agreements. These caps are fixed for the entire four-year term of government and are segmented across three main sectors: central government, social security, and health care. The thinking on the three sectoral ceilings has been to have health care and social security solve budgetary issues within their sector. However, in practice, extra expenditure on health has often been financed with the surpluses under the other two ceilings. The Dutch framework is further strengthened by the Netherlands Bureau for Economic Policy Analysis (CPB), an independent body that produces official short-term, medium-term, and long-term macroeconomic projections, as well as evaluates policy and alternative budgetary proposals. The CPB’s work helps to anchor expectations and prevent overly optimistic forecasting bias.

Switzerland’s “debt brake”, introduced in 2003, is a constitutional rule that effectively imposes a central government expenditure ceiling adjusted for the economic cycle. The debt brake is designed to ensure that fiscal policy remains sustainable over the long term by aiming to keep nominal debt stable (i.e. a declining debt-to-GDP ratio). The rule also considers the economic cycle to help smooth growth fluctuations. It is a structural deficit rule that limits expenditures to the amount of structural (i.e. cyclically adjusted) revenues. Thus, the debt brake does not require budgets to be balanced on an annual basis, but only over an economic cycle. Within this mechanism, total federal government expenditures are kept relatively independent from the cycle, whereas tax revenues act as automatic stabilisers. Actual deviations from the limit set by the rule result in a credit or debit to the so-called “compensation account”. Deficits in this account must be considered when setting the new expenditures ceiling for the following year and eliminated in the subsequent years. Moreover, in principle, positive balances from underspending can only be used to reduce debt.

In extraordinary circumstances (such as severe recessions, pandemics or natural disasters), the expenditure ceiling can be raised by a qualified majority of both chambers of parliament, whereby a binding rule also applies for the extraordinary budget. Extraordinary receipts and expenditures are recorded on an amortisation account and any deficits on the amortisation account due to extraordinary expenditures must be covered over the course of six years by means of surpluses in the ordinary budget. In special situations, the parliament has the power to extend the six-year deadline.

In the EU, the expenditure growth rate must be in line with medium-term potential growth (computed over the past five years, the current year and a projection of four years ahead) if the country is at its medium-term objective (MTO). These objectives depend, among others, on the country’s debt ratio and deficit level. If the country is not yet at its MTO, the rate of growth of the expenditure benchmark must be below the medium-term potential growth. Public investment is smoothed over four years to exclude the effects of the investment cycle and the temporary impact of exceptionally large investment projects from the annual assessment.

When assessing compliance with the rules, the European Commission considers the so-called pension reform, structural reform and investment clauses. This means that under certain conditions specified by the rules, a country can deviate from the structural balance rule if this deviation is due to the costs of a pension, structural reform, or public investment, which has positive effects on growth.

Source: The 2024 OECD Survey for Switzerland (2024[41]); Assessing Chile's analytical framework for long-term fiscal sustainability (OECD, 2021[12]); (Bos, 2007[42]).

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Annex 1.A. Projected employment rates

Annex Figure 1.A.1. Projected employment rates under different integration scenarios

Source: OECD calculation.

Notes

← 1.  Despite being a widely used measure, the old-age dependency ratio has the important drawback that it fixes the “old-age” threshold at a fixed number, typically at 65 years (as this report does), while healthy ageing implies that working age is likely to increase going forward.

← 2.  Budget decisions for year t are made in t–1 using data available up to t–2.

← 3.  The nominal component, added to the real expenditure growth rate in the above equation, is defined as the average inflation rate over the three years prior to the budget decision (i.e. from t-4 to t-2).

← 4.  Relying on expenditures data up to 2025 creates a risk that the Israeli economy's current position along the business cycle will affect the results. An alternative approach is to rely on projections for total government outlays in the OECD economic outlook to project total expenditures up to 2026 and keep the share of each spending category in total government spending constant.

← 5.  A public commission that was established by the Prime Minister to recommend on the force building needs and the defence budget for the coming decade. Nevertheless, since the committee’s recommendations were published, the geopolitical environment has undergone some changes, which may have affected defence needs.

← 6.  In the baseline, the labour share was assumed to be 0.67 as in all other OECD countries. However, it is lower in Israel. A sensitivity analysis assuming equal weights (0.5) for both effective labour and capital showed that the projected annual average growth rate would change marginally, adding less than one-tenth of a percentage point. Cumulatively, this could result in potential GDP being around 2% higher by 2050.

← 7.  Which means that the projected demographic changes will not affect the quality of governance or the rule of law.

← 8.  As the investment-to-GDP ratio remains broadly constant in the second part of the projection period while potential GDP growth slows, the capital-to-output ratio is expected to continue rising.

← 9.  Due to noisy data in recent years.

← 10.  Assuming wage growth of NHJO men and women would have been similar to what it was between 2002 and 2016.

← 11.  As the healthy ageing ratio is assumed to rise from 0.5 in the baseline to 0.6. The implicit assumption is that the cohort-based approach used to project future employment rates includes a healthy ageing effect of 0.5.

← 12.  Assuming constant employment rates per age group, changing the age composition of the working population will decrease the average employment rate by 0.1 percentage point.

← 13.  Taking 2026 instead of 2025 as the reference year, upward pressures only amount to 2.9% of potential GDP (mainly due to higher transport spending), while downward pressures are reduced to 5.1% (driven primarily by the expected short-term decline in defence spending). This results in a net decline in total annual spending of 2.2 percentage points by 2065.

← 14.  Besides the direct labour market effects, the integration of Haredi men also has spending implications through their participation in military service. Greater involvement of Haredim could reduce the burden on non-Haredi Jewish men serving as reservists, who are typically highly productive, allowing them to dedicate more time to civilian work and thereby increase overall output.