Long‑Term Spending Projections in Israel

Executive summary

Over the past decades, Israel has made notable progress in improving its public finances. The general government debt-to-GDP ratio declined from over 90% in the early 2000s to below 60% in the years leading up to the COVID-19 pandemic. This was achieved alongside a reduction in tax rates and sustained economic growth, supported by rising labour force participation and low borrowing costs. However, demographic shifts, particularly the rising share of population groups with weaker labour market attachment and increased longevity, a reversal in the interest-rate-GDP-growth differential and redefined defence needs threaten to weigh on fiscal sustainability over time. In contrast, a slowdown in fertility from a high level could put downward pressure on public finances for several decades due to lower education spending and transfers to families.

To help policymakers better anticipate and address upside and downside risks, at the request of the Israeli Ministry of Finance, the OECD developed a model for long-term fiscal scenario analysis. Using an adapted version of the OECD Long-Term Model, the model provides 40-year projections of GDP, government expenditures and key fiscal indicators. The model is calibrated to Israel’s demographic structure and labour market patterns, including distinctions between non-Haredi Jews, Haredim, and Arab Israelis. It allows for dynamic analysis of how different assumptions – on employment, productivity, population growth, and policy reforms – shape fiscal outcomes over the long run.

GDP per capita growth is expected to stabilise over the long-term

In the baseline scenario, future labour force developments are based on recent trends, resulting in limited economic integration of the Arab Israelis and especially Haredim with the majority population. Capital levels are expected to improve and approach levels comparable to those in the OECD average, albeit slowly. This baseline business-as-usual scenario (Baseline scenario hereafter) suggests that Israel’s annual potential GDP growth will gradually moderate from about 3½ per cent today to 3¼ per cent by the early 2030s, 3% by the early 2040s, and 2½ per cent by 2065 (Figure 1). A gradual deceleration in the growth of the working-age population mainly drives this decline. Nonetheless, the growth of GDP per capita, a key indicator of the standard of living, is expected to remain generally stable and surpass that of most OECD countries. It would be supported by a projected increase in women’s employment rate, a rising share of working-age individuals in the total population and a modest convergence of labour efficiency towards the efficiency frontier. Wage growth is projected to track productivity per worker, increasing by about 1.4% annually until 2065.

Figure 1. Potential GDP growth is projected to moderate

Potential output growth decomposition

Note: To align with current fertility trends, population projections combine the CBS median and low population growth scenarios.

Source: OECD calculations.

Fiscal pressure is expected to ease in the long run

Fiscal pressures are expected to ease in the baseline scenario. General government expenditure is projected to rise modestly in the medium term, peaking at 40.2% of potential GDP in 2036, which is around 0.4 percentage points above the forecasted 2026 level. Thereafter, it is expected to decline gradually to 37.5% by 2065 (Figure 2). Behind this development lie diverging trends. Assuming a constant debt-to-GDP ratio and maturity structure from 2026 onwards, debt servicing costs are expected to rise significantly during the 2030-2040s, reflecting the impact of rolling over debt at higher interest rates. Transfers of payments paid by the National Insurance Institute (NII) to elderly people and health spending will also contribute to upward pressure driven by population ageing. However, these increases are projected to be more than offset by declining expenditures in other areas, particularly in non-NII social protection, education, and family-related programmes. The reduction in non-NII social protection spending stems largely from earlier pension reforms, which curtailed entry into non-funded defined-benefit pension schemes for public-sector employees in the early 2000s and reduced government support for the actuarial balance of legacy pension funds. Meanwhile, the moderation in growth in education and family-related spending is linked to a declining share of children in the population. Spending on early childhood education, for example, is expected to grow more slowly than potential GDP due to reduced fertility, although improvements in Arab women's labour force participation could create localised pressures.

Figure 2. Spending pressures are projected to ease after 2040

Change in total annual spending from 2026 (% of potential GDP)

Note: The reference year is set to 2026, as spending in 2025 – the first projection year – may differ substantially from the forecasts available when the projections were finalised. The baseline scenario assumes a constant debt-to-GDP ratio of 66% (projected for 2026), maintained through adjustments in taxation. Results are shown as a percentage of potential GDP to minimise the effect of the large output gap. Only legislated increases in the retirement age are considered. Social protection allowance levels are projected to grow in line with historical trends rather than in accordance with legislated changes.

Source: OECD calculations.

Demography and labour market integration will be key factors determining long-term fiscal outcomes

Multiple alternative scenarios were developed to address the significant uncertainty inherent in this type of analysis and to underscore the potential effects of reforms (Table 1). A key finding is that the pace and success of labour market integration will be a major determinant of future economic activity and, therefore, fiscal outcomes. In a scenario where the Haredim and Arab Israelis progressively converge toward the majority population in terms of employment rates, working hours and labour productivity – an Economic Melting pot scenario (hereafter Melting pot) – GDP per capita is projected to rise by 8% and government spending to decline by 0.8% of potential GDP relative to the baseline by 2065. By contrast, a Frozen rates scenario, where current employment disparities persist, results in a 4% decline in projected GDP per capita and an increase of 1.1% of potential GDP in total general government expenditures relative to the baseline. These divergences are driven primarily by the expected integration of Haredi men, a rapidly growing population group whose labour market convergence has remained limited over the past decade.

Demographic assumptions also play a central role. In a Higher population growth scenario – driven by elevated fertility – projected government spending rises by as much as 2.2% of potential GDP by 2065 compared to the baseline, due largely to increased demand for education services. The analysis also includes an Ageing-related policy reform scenario (hereafter Policy reform scenario) where the female retirement age is gradually increased to match the male age by 2040, and both are indexed to life expectancy gains afterwards. It also assumes reforms improving prevention and healthcare efficiency, resulting in healthier ageing and reduced need for disability and long-term care benefits. This reform package yields fiscal savings of 0.7% of potential GDP by 2065, slightly less than the Melting pot scenario. The savings are mainly driven by increasing labour force participation among older adults, especially women, and lower transfer payments.

Table 1. Faster labour market integration could boost potential output growth

GDP growth and projected spending in the alternative scenarios

Scenario	Working age population, average annual growth (%), 2025-2065	Potential GDP, average annual growth (%), 2025-2065	Potential GDP per capita, average annual growth (%), 2025-2065	Projected total spending, as a % of potential GDP, 2045	Projected total spending, as a % of potential GDP, 2065
Baseline	1.38	2.95	1.64	39.5	37.5
Frozen Employment Rates	1.38	2.85	1.55	40.2	38.6
Economic Melting pot	1.38	3.15	1.84	39.0	36.7
Slower Population Growth	1.21	2.98	1.74	39.1	37.5
Faster Population Growth	1.57	3.03	1.45	40.3	39.7
Ageing-related policy reforms	1.38	2.99	1.68	39.1	36.9

Note: The underlying assumptions in the different scenarios are described in detail in Chapter 1 of the report (Table 1.4). Ageing-related policy reforms refer to an increase in the statutory retirement age beyond currently legislated levels and a faster decline in morbidity than in the baseline, although similar expected life expectancy.

Source: OECD calculations.

These results suggest that Israel should be able to at least stabilise its debt-to-GDP ratio without requiring implausibly large policy adjustments. Stabilisation would require measures equivalent to an increase in general government revenues from 36.1% of potential GDP in 2026, as projected in the OECD Economic Outlook, to 36.9% by 2036. However, due to the demographic dividend easing spending pressures from the 2040s, revenues could fall below current levels from 2048 onwards. Nonetheless, if no action is taken to close the current structural deficit and address medium-term fiscal pressures linked to higher interest rates, Israel’s indebtedness could rise substantially. Under unchanged revenue and spending policies, the debt-to-GDP ratio could rise to about 77% by 2048.

Structural reforms could help maintain public finance in a healthy position and leave fiscal space for growth-enhancing spending on infrastructure and skills development. In this regard, as recommended in the 2025 OECD Economic Survey of Israel, promoting greater labour market integration by removing government subsidies for Yeshiva students, conditioning childcare support on fathers’ employment in addition to mothers', and lengthening working lives will be key. Monitoring long-term fiscal developments should be institutionalised and extended to include the revenue side to support evidence-based policymaking and improve fiscal transparency.