Boris Cournède
OECD
OECD Economic Surveys: Israel 2025
Abstract
Geopolitical tensions in the Middle East continue to shape economic developments. Labour shortages in construction are constraining investment. Faced with resurgent price pressures, monetary policy has remained appropriately tight. The high level of risk calls for maintaining sufficient capital buffers among banks. Fiscal policy should contain deficits in 2025-2026 and then secure debt sustainability. Revenue increases and careful spending prioritisation will be needed to ensure debt sustainability. Structural policy adjustments to favour greater employment and productivity across population groups would support fiscal sustainability and long-term growth.
1.1.1. The economy remains heavily affected by the evolving conflicts
After a sharp post-COVID-19 rebound, the Israeli economy was experiencing robust but moderating growth with inflation remaining above target. The 7 October 2023 terrorist attacks changed the growth outlook substantially. Schools and many services closed for three weeks. The suspension of work permits for Palestinians, who provided a third of the construction workforce, as well as the departure of many foreign workers, halved the number of non-Israeli workers from 6.7% of employment before October 2023 to 3.5% two months later. Investment shrank by 26% in the last quarter of 2023 mainly due to a sharp decrease in construction. Government consumption soared on account of military expenses, rising to a fifth above its pre-war levels in 2024.
Considering the circumstances, the economy has been resilient. Consumption quickly recovered from its post-7-October-2023 slump at the end of 2023 and beginning of 2024. Households have however been more cautious in the rest of 2024 as the conflicts widened, with private consumption growing sluggishly and household confidence staying relatively weak. Business confidence by contrast has been stronger, with stock markets more than recovering from post-October 2023 losses. The positive effect of business confidence on investment has however remained constrained by persistent labour shortages. Few new foreign workers (0.4% of employment) have entered Israel since work permits were suspended for Palestinians (who made up 4% of employment in Israel before the war). Continued rocket attacks reduced industrial and farm production in Northern areas in 2024. With supply constraints, the recovery was quickly followed by a pick-up in inflation from 2.5% in February 2024 to 3.5% in September 2024.
The evolving conflicts have been impacting foreign trade. Ship attacks in the Red Sea have made merchandise shipping more expensive, while a sharply reduced number of airline connections has complicated international business. Intensifying tensions in the second half of 2024 had repercussions on the high-tech sector, halting the rally in high-tech shares, even if foreign direct investment in high-tech was robust in 2024. Inward foreign tourism remains nearly absent.
1.1.2. Growth is expected to pick up
On the assumption that conflicts ease in 2025-2026, activity is projected to rebound from 3.4% in 2025 to 5.5% in 2026 (Table 1.1). Exports are anticipated to accelerate as the business environment improves in 2025, facilitating trade including in high-tech services. Private consumption should broadly follow the same path apart after the slowdown at the beginning of 2025 owing to the VAT rise. Investment remains constrained by labour shortages, reducing supply capacity, which may over time contribute to inflation. Inflation is projected to rise in 2025 to 3.7% before moderating to 2.9% in 2026 under the effect of fiscal contraction and reduced supply constraints.
Risks are very large on both the upside and downside.
On the upside, a renewed reduction of of geopolitical tensions would further ease supply constraints, especially relating to labour shortages and lower risk premia. These developments would allow a rapid recovery in construction as well as stronger foreign trade and investment and faster return of foreign tourists, all prompting a faster-than-projected upturn. Fundamental improvements in the geopolitical situation could unleash considerably stronger long-term growth.
On the downside, continued intensification of the conflicts could substantially degrade public accounts while directly reducing output if conditions require stopping certain activities. Loss of foreign-investor confidence could result in renewed increases in government bond yields and put pressure on financial and foreign-exchange markets. Ample foreign-exchange reserves, covering 20 months of imports, however, provide cushion against external shocks.
Notes:
1. OECD Economic Outlook No. 116 database, with updates, and OECD Annual National Accounts database for 2024 GDP growth.
2. Contribution to changes in real GDP.
3. Index of consumer prices excluding food and energy.
Source: OECD Economic Outlook: Statistics and Projections database.
1.1.3. Current shortages and longstanding gaps in the labour market hold back activity
Labour shortages in construction constrain investment
Residential construction contributes more to GDP in Israel than in most other OECD countries (Figure 1.1 Panel A). The civil protection measures taken in the immediate aftermath of the 7 October attacks resulted in a temporary closure of construction sites. Consequently, homebuilding activity more than halved in the fourth quarter of 2023, while other construction contracted by 27% (Figure 1.1 Panel B). The reopening of construction sites triggered a fast rebound. However, the suspension of Palestinians’ work permits immediately after 7 October 2023 has caused severe labour shortages that have limited the size of the construction recovery: before October 2023, Palestinians represented a quarter of the construction workforce.
Medium-term prospects for construction and other labour-intensive sectors such as agriculture largely hinge on employment, following the suspension of Palestinians’ work permits. The policy goal of the Israeli authorities is to attract foreign workers from other countries including India, Moldova and Sri Lanka. Between September 2023 and September 2024, the number of foreign workers has risen by 22,000,considerably short of the 170,000 Palestinians who worked in Israel in the third quarter of 2023 (Central Bureau of Statistics, 2024[1]; Population and Immigration Authority, 2024[2]).
Notes: Data refer to gross fixed capital formation. In, Panel A, the construction shares are computed in value. In Panel B, construction is measured in volume.
Sources: OECD National Accounts database; and OECD calculations.
Persistent labour shortages in construction would have a continued direct constraining impact on GDP through lower building activity but also knock-on effects on the availability of built structures including homes. This is an important difference with sectors such as farming, where imports can substitute for local production, even if effective barriers to trade can complicate this adjustment (Chapter 4).
Stylised scenarios based on estimated past relationships illustrate the difference that labour-policy choices make for the housing sector. Israel’s fast population growth requires a quickly expanding housing supply (Figure 1.2 ). Supply was rising strongly in the period immediately before the war, reflecting measures to facilitate construction, including through urban renewal programmes and post-COVID-19 catch-up (Chapter 4 and Figure 1.2). If labour shortages persist, the net supply of new dwellings risks lagging the needs of a growing population, resulting in a housing deficit opening up over time (Figure 1.2).
Continued action to remedy labour shortages is important to allow adequate levels of construction including in the residential sector. If foreign workers come in numbers comparable to Palestinian workers ahead of October 2023, then homebuilding can pick up back to its pre-October-2023 GDP share. A difference is that these workers need accommodation in Israel, whereas Palestinian workers go home at night. Foreign workers however require fewer additional dwellings compared with a same-sized increase in the rest of the population given their usual lodging arrangements. Stylised simulations suggest that a housing deficit could temporarily open in the scenario with foreign workers (Figure 1.2). By contrast, ending the suspension of work permits for Palestinians would allow homebuilding to expand without creating new housing needs (Figure 1.2).
Deviation of actual from equilibrium number of dwellings, %
Notes: Dotted lines refer to projections. The equilibrium number of dwellings is estimated through a co-integration relationship with population over 1995-2023. Population numbers follow the assumptions underpinning the OECD Economic Outlook No. 116 long-term baseline except in the “Hosting new foreign workers in equal numbers with 2023 Palestinian workers” scenario, where case it is assumed that foreign workers enter Israel in 2025 in numbers equivalent to the number of Palestinian workers in the country in 2023Q1-Q3. The stylised scenario assumes that their impact on housing needs is a third of that of the local population since many live in barracks or share flats. Dwelling numbers are forecast by adding to the previous year stock a new number of net deliveries that is estimated based on the volume of construction activity. The regression linking new homes to homebuilding (and a time trend) is estimated on 1995-2023 data with very tight fit (R2=97%). The forecast over 2024-2028 is then produced by holding constant the last residual constant (in logarithm form). A negative residual is observed in 2022-2023 reflecting a sharp rise in the share of demolition-rebuilding, upward extensions and heavy renovations among new dwellings delivered (see Chapter 4). In the baseline scenario, the homebuilding share in GDP stays at its last observed historical value (2024Q3). This can be considered an optimistic hence conservative assumption if all the labour potential has been exploited already at the time of the last observation. In the other two scenarios (dotted brown and green lines), the homebuilding share in GDP goes back to its (much higher) 2023Q1-Q3 ratio.
Sources: Israel Central Bureau of Statistics; OECD Economic Outlook 116 database; and OECD econometric estimates.
Tackling participation and skill gaps between population groups is a central policy requirement for sustained long-term growth
A source of long-standing unrealised potential for the Israeli economy is the weak labour-market attachment that characterises large population groups. Many Haredi (ultra-orthodox) men and Arab-Israeli women stay out of employment (Figure 1.3). Part-time work is prevalent among Haredi women (Figure 1.3). This situation to some extent reflects cultural choices, such as many Haredi men opting for long religious studies in yeshivas.
Alongside cultural factors, public policy settings are influencing women’s and men’s decisions to seek work or not. They include subsidies for yeshiva students, whose recipients are considered as employed for the purposes of eligibility to childcare support that is conditional on both parents working (Betz and Krill, 2019[3]). Lack of childcare, particularly in Arab-Israeli municipalities, complicates labour-market participation for Arab-Israeli women. Previous reductions in childcare costs in Israel have raised employment rates among mothers of young children (OECD, 2023[4]). The six-day length of the school week implies long school holidays, which in turn mean that schools are closed on many business days. This increases the burden of childcare for parents of school-age children, a burden that typically falls on mothers, who may consequently move into part-time, flexible or less-demanding jobs (OECD, 2023[3]). Besides suggesting benefits from reforming the school week, this situation underscores the benefits of expanding, and facilitating access to, childcare. As recommended in the previous Survey, a range of reforms are available to increase participation among women and across population groups (Table 1.2).
Notes: In Panel A and Panel B, data for the Haredi and non-Haredi Jewish groups do not include persons living outside localities (Bedouins in the South) or in institutions (permanent samples). In Panel B, data for Arab, Haredi and non-Haredi Jewish do not fully comply with the OECD harmonized definition of part-time workers.
Sources: OECD Labour Statistics database; Israel Central Bureau of Statistics (CBS); and OECD calculations.
There is considerable economic potential from closing gender gaps. Women in Israel earn wages that are on average more than a fifth lower than men’s, one of the highest differences among OECD countries (Gonne and Trincão, 2024[5]). Women are under-represented in the high-tech sector (see Chapter 2), partly reflecting a 30 percentage-point gender gap in entry into tertiary STEM studies, one of the largest gap across OECD countries (Gonne and Trincão, 2024[5]). By contrast, the share of women on listed companies’ boards , at 26.7% in 2021, was near the OECD average of 27.7% (Denis, 2022[6]).
Demographic trends mean key determinants of Israel’s growth trajectory in future decades will be the share of Haredim in employment (Box 1.1) and the productivity levels of the jobs they take. Economic benefits of greater Haredi labour-market inclusion would include both individual and social benefits, helping to overcome a currently high poverty rate of 39.5% (Ben-David, 2024[7]). To achieve progress towards higher participation as well as higher productivity levels and wages, with potentially large long-term growth benefits (Box 1.3), policy reforms are required in the areas of work incentives and education.
Policy changes over 2023-2024 have mostly reinforced Haredi men’s disincentives to work. There has been a substantial rise in budgetary support for yeshivas (seminar), whose students stay outside the labour force and are exempt from military service. On the other hand, in 2024, the High Court has ruled that the Haredim ought to be enlisted in the armed forces. Reportedly, however, few have effectively joined defence forces. Military duty can be a powerful channel for greater labour-market inclusion through the formation during this period of a network of contacts that can facilitate taking up employment or starting a business. Another one is the acquisition of dual skills that can also prove valuable in the civilian labour market. Additionally, enlisting Haredim allows freeing reservists for many days every year, allowing them to contribute more to civilian production (Tur-Paz and Gordon, 2024[8]).
Education and skill policies offer important additional avenues for narrowing labour-market gaps with a strong potential impact on Israel’s overall economic performance, as outlined in previous Surveys and Chapter 2. The reason is that large differences currently separate average educational outcomes across population groups (Figure 1.5 Panel A). These in turn reflect discrepancies in funding between Arab and Hebrew education streams (Figure 1.5 Panel B) as well as incomplete coverage of the core curriculum for Haredi pupils, especially boys (Ben-David, 2024[7]).
A key policy lever is to reallocate budgetary resources away from educational institutions that refrain from fully teaching the core curriculum towards those that do, with priority to currently underfunded ones (Koelle, 2023[9]). This reallocation would encourage core curriculum studies among young Haredi while freeing resources for currently comparatively lower-funded schools, including many in the Arabic-language sector. For Haredi boys, acquiring core-curriculum competencies, including in mathematics and English, would facilitate their later employment while enhancing their wage prospects. The same outcomes would arise for Arab-Israeli pupils from receiving higher-quality primary and secondary education (Ministry of Finance, 2021[10]). Furthermore, work placement and life-long programmes should be reviewed to ensure adequate coverage of Haredim and Arab-Israelis (Koelle, 2023[9]).
With the highest total fertility rate (TFR) among OECD countries, Israel experiences strong population growth. Another key demographic feature is the fertility difference between population groups. While all groups have TFRs significantly above the minimum replacement rate of 2.1, the Haredim (ultra-orthodox Jews) have a much higher TFR than other groups, implying that their share in the overall population is set to increase considerably over coming decades. Haredim’s share among people aged between 25-29 is consequently set to rise from 13% in 2025 to 28% in 2060 in CBS projections. By comparison, the share of Arab-Israelis in the overall population aged 25-29 is projected to remain roughly stable around 21% over the same period.
2020-2022 average
Note: The total fertility rate is the average number of children born per woman over a lifetime.
Sources: Central Bureau of Statistics and OECD (2024[11]).
The labour-market participation choices of members of currently under-represented groups will have deep implications for the employment potential, and therefore the prosperity, of the Israeli economy (Figure 1.4). The reason is that Haredim and Arab-Israelis currently are significantly more likely to be out of employment than non-ultra-orthodox Jews (Figure 1.3). The high share of the Arab-Israelis in the population (21%) and the quickly rising share of Haredim imply that trends in their labour-market participation will drive the number of people in employment relative to the overall population.
Labour force as a share of the population aged 15 and more, %
Notes: The “unchanged participation rates” scenario assumes that participation rates by age, gender and population group will remain as in 2023, so changes are driven by the demographic composition. The "convergence" scenario predicts declining entry and exit rates, allowing Haredi men to close 75% of the participation gap in prime ages with Jewish non-ultra-orthodox men, Arab men to close 69%, and Arab and Haredi women to close 90% of the gap with Jewish non-ultra-orthodox women. The scenario of “new progress at past pace” assumes that the recently observed differences in employment propensities across various cohorts will persist, along with improvements in the participation of new generations of Arab women in line with historical trends.
Sources: Central Bureau of Statistics of Israel; OECD Economic Outlook No. 116 database and OECD (2025, forthcoming[12])simulations.
Quantitatively, work currently underway by the OECD (2025, forthcoming[12]) points to different plausible long-term scenarios for Israel’s labour market. If forthcoming generations participate in the labour force with the same participation rates per group as current ones, the ratio of the labour force over the population aged 15 and more will decline by two and a half percentage points over 2030-2060 (Figure 1.4). By contrast, if the participation by Haredi and Arab Israelis converges towards that of non-ultra-orthodox Jews, this ratio will rise by 3.3 percentage points over the same period (the “convergence” scenario on Figure 1.4). In a middle-of-the-road scenario where past improvements in participation rates are repeated in the future, the same ratio rises by 0.2 percentage points over 2030-2060. In turn, the size of the labour force relative to the whole population has far-reaching consequences for economic performance (Box 1.3) and fiscal sustainability (Box 1.6).
Notes: Panel A, most Haredi boys do not take the PISA test. Panel B, data are unavailable for Haredi schools, which operate under a separate budgetary system.
Sources: Ben-David (2024[13]) and Blass and Bleikh (2024[14])
1.1.4. Further productivity-enhancing reforms would buttress long-term growth prospects
Besides labour-market outcomes among the fast-growing Haredi population, another factor that will influence growth over the long run is the impact of larger defence commitments. The authorities are considering permanent increases in military expenditure (see fiscal section below) and reserve duties. The evidence on the economic effects of military spending is mixed, with significant potential for negative effects on long-term growth (Box 1.2). The planned increase in reserve days from 18 to 42 days for soldiers and 28 to 55 days for officers is bound to complicate the organisation of production (Tur-Paz and Gordon, 2024[8]).
The challenges of this new environment magnify the benefits of structural reforms to boost growth (Box 1.3), as these can offset negative effects from larger defence commitments. Implementing the economic policy options to reduce the cost of living (see Chapter 4) would have positive effects going well beyond a lower price level. Reforms that open economies to competitive pressure from trade and domestic competition have a proven track record of unleashing productivity growth, in turn boosting investment and employment (Égert and Gal, 2017[15]). The above-mentioned policies to enhance labour-force participation and skill acquisition among the Haredim and Arab-Israelis would boost aggregate employment and productivity.
The economy would benefit from strengthening public investment management, allowing a broadening of the public-capital base, which is currently low by international comparison (Figure 1.6). As highlighted in previous Surveys, better public infrastructure would support growth including by easing road congestion from its currently elevated levels and by facilitating the uptake of public transport, and there is scope for streamlining regulatory and administrative procedures. As developed in Chapter 2, higher public investment could contribute to buttressing the computing and network infrastructure for AI research and for its deployment across the economy.
Ongoing conflicts following Russia’s war of aggression against Ukraine and the 7 October 2023 terror attack on Israel as well as heightening geopolitical risk in the Asia-Pacific have led many OECD countries to spend more on their defence. In the economic literature, the link between military expenditure and economic activity has long been a subject mostly focusing on developing nations. While defence spending in OECD countries shrunk to low levels in the aftermath of the Cold War, generating a peace dividend (Berthélemy, McNamara and Sen, 1994[16]; OECD, 2023[17]) , renewed conflicts and tensions have put the question to the fore. This box summarises available evidence from the literature on potential positive and negative economic effects.
Potential growth-enhancing economic effects of military expenditure
Besides its accounting contribution to GDP in the forms of public consumption and investment, defence expenditure can have broader economic effects by spurring technological advancements, particularly through research and development (R&D). Defence-related R&D can produce innovations, some of which may have substantial technological spillover effects in the civilian sector (Adams and Gold, 1987[18]). For example, the internet, GPS, and many advanced computer systems originated from military research but later became vital components of the civilian economy. The investment component of defence expenditure has been empirically found to associated with subsequent higher long-term growth in OECD countries (Fournier, 2016[19])..
Negative economic effects of military expenditure
There are also significant downsides to military spending, particularly in the long run. One of the primary concerns is the crowding-out effect. Defence expenditure competes with other forms of public spending, crowding out in spending on key areas for long-term growth such as education, healthcare, and infrastructure development (Azam, 2020[20]). The large part of military expenditure that is spent on imported equipment and to maintain standing armies brings no spillover benefits to the rest of the economy.
Another concern is that military expenditure can distort resource allocation, reducing aggregate productivity (Hong, 1979[21]). When a significant portion of skilled labour is employed in the military or defence industries, these workers are unavailable for civilian projects. In Israel, this can be a cause for concern especially in the high-tech sector given the shortages of highly skilled labour (see Chapter 2).
Table 1.4 provides illustrative quantitative estimates of the benefit in terms of GDP per capita of selected main recommendations in this Survey using the OECD long-term modelling framework (Guillemette and Château, 2023[22]). As developed in Chapter 4, product market reforms are assumed to cut red tape, reduce state involvement in the economy and lower barriers to entry, so that Israel reaches the OECD average on the PMR indicator. Trade barriers are lowered through the introduction and deepening of free trade agreements, lower tariffs, less technical barriers to trade and trade facilitation measures. The education reform scenario assumes that educational outcomes of currently underperforming groups (Haredim and Arab-Israelis) converge over ten years to the ones observed among secular and religious (non-ultra-Orthodox) Jews. Consequently, total factor productivity increases gradually in the illustrative reform scenario as cohorts having benefited from education reforms enter the working-age population. Withdrawing subsidies and other policies discouraging labour-market participation of Haredim and Arab-Israelis is assumed to gradually improve labour supply over time.
Relative to the “unchanged policies” scenario
Notes: The estimates rely on Égert and Gal (2017[15]) for trade and product-market reforms, Guillemette and Turner (2018[23])for public investment using the elasticity for Israel reported in Section 4.4, Égert, de la Maisonneuve and Turner (2023[24]) for education reforms and a demographic model for the greater labour-market participation of Haredim and Arab-Israelis (which assumes the achievement of half of the improvements in the “convergence” scenario described in Box 1.1).
General government non-financial assets, as % of GDP, 2022 or latest available year
Source: OECD National Accounts database.
Inflation has been rising since the beginning of 2024, going above 3% in July -- the upper bound of the central bank target range -- and reaching 3.6% in August 2024. Inflationary pressures are widespread: core inflation, a measure that excludes food and energy, two areas with large price swings, also increased substantially, by one percentage point over the same period. Another indicator of the widening breadth of price pressures is that, since the beginning of 2024, more of the goods and services consumed by Israeli households have recorded price increases in excess of 3%.
Notes: Trend unemployment is calculated as a Hodrick-Prescott HP filter of observed quarterly unemployment (lambda=1600) and OECD Economic Outlook No. 116 projections up to 2026Q4 to avoid end-point bias. The calculation corrects for the impact of COVID-19 by replacing the observed unemployment rate during COVID-19 (2020Q2-2021Q4 in Israel given early vaccination) with its trend (calculated in a preliminary stage also with a HP filter).
Sources: OECD Price Statistics database; and OECD Economic Outlook: Statistics and Projections database.
1.2.1. Supply disruptions and constraints are contributing to inflation
The conflicts are weighing on production and the labour market
The return of inflation stems in part from adverse supply shocks while the surge in war-related government spending has supported demand. The terrorist attacks of 7 October 2023 and the continued rocket attacks on the north of Israel since then have severely disrupted agricultural production. Food prices have consequently risen sharply, contributing one percentage point to overall inflation in August 2024. Rocket attacks on the north of the country severely impaired industrial production as well as the activity of high-tech companies operating in the area (such as food-tech firms).
The war has involved a large mobilisation: in the year from October 2023, nearly three hundred thousand reservists (6.5% of the workforce) served in the armed forces for an average of 61 days each (Israel Defence Forces, 2024[25]). In addition to a direct effect equivalent to a 1.1% reduction in the civilian labour force, this enlistment has also had consequences for partners of the mobilised soldiers. Many reduced their working time as they had to take care of family duties singlehandedly during their partners’ duty periods. Reserve calls have also complicated the organisation of production for employers.
Housing could contribute to overall price pressures if labour shortages keep constraining homebuilding
Housing-supply imbalances influence rent developments and CPI inflation in addition to bearing on living standards (Chapter 4). Lack of sufficient housing translates into higher rents: with housing making up 26% of consumption as recorded in the CPI, including imputed rents for homeowners, changes in rent have strong effects on overall inflation. Over the past three decades, movements in housing supply above or below demographically-driven equilibrium levels of housing have had quantitatively large effects on the dynamics of rents.
Looking ahead, the sharp homebuilding contraction of end-2023 may have significant effects over time if labour shortages in construction remain widespread (Table 1.5). Given construction lags, the end-2023 contraction will result in reduced deliveries by comparison with pre-October-2023 trends in the course of 2025. Even though homebuilding rebounded in 2024, residential construction remained in the third quarter of 2024 more than 25% below its level in the third quarter of 2023. The contraction appears more limited when considering housing starts, which in the third quarter of 2024 were only 8% below their level a year before, suggesting that a number of developers may still start projects despite uncertainty about the possible pace of construction.
If labour shortages persist, the supply of housing could go below trend, with the effect that housing would put increasing pressure on inflation over time through market and imputed rents. As of November 2024, rent inflation is running a yearly rate of 3.6% for market rentals (and 4.0% for homeowners’ imputed rents). Despite high mortgage rates, dwelling prices increased by 6.7% in the twelve months to September-October 2024. These indicators suggest that tensions may be building already in the housing sector despite the relatively high number of new dwellings available for sale at 71,000 in November 2024, which is equivalent to about 21 months for sale, a ratio of inventory to sales that is comparable to January-September 2023. An explanation could be a mismatch between some of the new supply and the characteristics that buyers are seeking in terms of location or features (Mirovsky, 2024[26]).
Policy levers are available to mitigate the risks of such pressures building up. Addressing labour shortages through facilitating entry of more foreign workers and/or ending the suspension of work permits for Palestinians would avoid the gradual widening over time of a housing gap. Another avenue for more homebuilding would be to encourage productivity enhancements, even if international experience suggests that this is challenging as productivity growth in residential construction has been very weak or even negative over recent decades across countries (Kane and Lopez, 2023[27]). Measures discussed in Chapter 4 can help to remove obstacles to housing-supply adjustment by easing regulatory constraints on homebuilding, further facilitating densification in areas of demand and considering social-housing construction. By contrast, subsidies to help low-income tenants pay their rent need to be carefully targeted and limited in size and time as otherwise they risk further feeding rent inflation (Chapter 4).
Estimated medium-term (2029) effects, Percentage points
Notes: The stylised scenarios are those underpinning Figure 1.2. The simulations combine the housing-supply trajectories in these scenarios with econometric estimates of the link between the housing gap (effective minus population-based equilibrium supply) and rent changes. The housing gap that separates actual from equilibrium dwellings (Figure 1.2) is tightly linked to rent movements. Econometric regressions using the previous year’s housing gap and inflation excluding housing explain more than six tenths of the variation in both actual and imputed rents (as measured in the CPI). Changes in actual and imputed rents are both statistically significant above the 95% confidence level while inflation is statistically significant at the 99% level.
Source: OECD simulations based on OECD Economic Outlook No. 116 and Central Bureau of Statistics databases.
1.2.2. Price pressures are set to remain significant
Demand factors have also been contributing to price pressures. The rapid rebound in consumer expenditure combined with the surge in government consumption more than offset the effect of lower investment. Due to the prolongation of the conflicts, the impetus from military-expenditure has been larger through 2024 than expected on 1 January 2024, when the Central Bank lowered the policy rate from 4.75% to 4.5%. In mid-2024, domestic demand snapped back to 2.7% above its pre-COVID-19 trend in mid-2024. Despite an increase after October 2023, unemployment remains below its long-term trend.
Inflation is set to remain strong in the first half of 2025 before moderating. The one-percentage point increase in VAT in January 2025 and supply constraints related to geopolitical tensions, which are assumed to remain elevated until the second quarter of 2025, will contribute to price pressures in the first half of 2025. Some wage pressure will come in the business sector from the tight labour market. The construction shortfall since October 2023 amid persistent labour shortages implies that, even after the shortages are addressed and investment can fully recover, the capital stock will for a time remain below equilibrium levels, constraining supply with implications for price pressures.
1.2.3. Keeping a careful monetary policy stance is appropriate
The increase in inflation through 2024 marked a turning point after a period of disinflation. A series of central bank rate increases implemented over April 2022-May 2023 brought down price pressures. Core inflation declined from over 5% at the end of 2022 to below 2% in early 2024. Over the same period, disinflation was broad based: items with price increases above 3% per annum went from making up more than half of consumption to less than a fifth of it. The share of consumption categories with above 3% inflation however rose through 2024.
Continued prudent demand management is appropriate to keep inflation under control. The stability-oriented macroeconomic policy strategy followed since October 2023 stands in contrast with the monetary financing of government spending that characterised the period after the Six-Day and Yom-Kippur wars (Box 1.4). Since this period, reforms including the independence of the central bank and the establishment of the fiscal framework have considerably strengthened monetary and fiscal institutions (Box 1.5).
The key monetary policy objective of keeping the CPI inflation rate between 1 and 3% attracts market credibility. After drifting to the upper part of the range during COVID-19 years, medium and long-term measures of inflation expectations have remained anchored within the target-range in recent years. The stability of these indicators below 3% reflects confidence in the inflation objective. This supports the monetary policy framework, which, looking backward, has been successful with inflation averaging 1.7% since the entry into force of the 1-3% target range in 2003. One-year-ahead inflation expectations, which are more sensitive to short-term developments, have moved up in line with inflation outturns in the course of 2024 without going above them: markets see the risk of a wage-price spiral as contained.
Large fluctuations in military expenditure that accompanied and followed the Six-Day (1967) and Yom Kippur (1973) wars deeply influenced the Israeli economy for decades. Defence spending surged after both conflicts: from less than 10% of GDP before 1967, defence expenditure soared to 30% of GDP from 1973 to 1976 (Figure 1.8). This increase reflected wartime expenditures in a first stage followed in a second stage by the decision to maintain larger defence forces than before owing to an upward re-assessment of military threats.
A central economic consequence of Israel’s high military spending was inflation. Government expenditures after 1973 rose to an average level of 75% of GDP until 1985 (Sargent and Zeira, 2011[28]). Despite an increase in public revenue, much of the rise in government spending was funded through deficits, which averaged 15% of GDP over 1973-1985. Monetary financing has been estimated to have covered a third of these deficits (Sargent and Zeira, 2011[28]). The resulting overly rapid expansion in money supply-fuelled inflation, which took off after the Yom-Kippur war to ultimately reach a rate of nearly 400% in 1985 (Figure 1.8) (Weissbrod and Weissbrod, 1986[29]).
In the wake of the Yom Kippur War, much of Israel's defence spending was allocated to imports (Figure 1.8), primarily of weapon systems from international markets, with only a third of the total increase in defence spending contributing directly to local economic activity (Lifshitz, 2023[30]). Large imports of military equipment, despite being partly funded by foreign aid especially from the United States, implied substantial current account deficits (Zeira, 2021[31]).
Source: Israel Central Bureau of Statistics (CBS, 2022[32]); and OECD Price Statistics database.
The surge in defence expenditure had evolving effects on Israel’s domestic economy. The initial effects were mostly of a cyclical nature: in particular, the rise in military expenditure at the time of the Yom Kippur War sustained economic activity in the face of global economic turbulence. Over time, the defence industry, especially weapons production, experienced rapid growth. Between 1965 and 1977, the defence sector grew at a rate of 15% annually, far outpacing the 7.9% growth rate of total industrial production. This expansion transformed Israel from a net importer of military goods into a global exporter, with weapons exports rising sharply in the 1970s and 1980s, accounting for nearly a quarter of industrial exports by 1985 (Labarge, 1988[33]; Mintz and Ward, 1989[34]). By the mid-1980s, the defence sector accounted for 50% of all industrial investments, and one in four industrial workers was employed in military-related production. The defence industry was dominated by a small number of oligopolistic firms, heavily reliant on government contracts. This concentrated market structure hindered competition and limited innovation.
Peace agreements, particularly with Egypt in 1979, enabled a decrease in defence expenditure. The shift from conventional country-to-country warfare to asymmetric conflicts, such as the First Intifada (1987-1991), accelerated this fall by reducing demand for large-scale military forces and heavy equipment. Public investment shifted toward non-defence sectors, particularly in industries like technology and services, which exhibited higher marginal productivity and became key drivers of economic growth (Cohen et al., 1996[35]).
Expected CPI inflation rates from swap contracts, %
Source: Bank of Israel.
Monetary authorities should keep interest rates on hold until inflationary pressures are well contained while remaining data dependent. There is little space for reducing rates given the inflation outlook, with the prospect of strong demand from private consumption and exports amid continuing labour shortages in 2025. Another reason to err on the side of caution is the need to keep long-term inflation expectations anchored – they are currently above 2.5%, though within the 1-3% target range. However, the improvement in the geopolitical situation at the turn of 2025 has resulted in an easing of supply constraints including by reducing reserve duty requirements and by allowing an increase in international air connectivity. Furthermore, the return of currency appreciation, if maintained, will lower medium-term price pressures (Figure 1.10). In this uncertain environment, the monetary policy stance should remain data-dependent to regularly assess supply-demand imbalances that shape the trade-off between inflation and output.
Israel’s monetary policy aims at keeping inflation between 1% and 3%. The Bank of Israel is responsible for meeting this 1-3% inflation target range, which the Government decided in 2000 with effect from 2003. The 1-3% target was reaffirmed in November 2024 following a review. Legislation enacted in 2010 gave overarching priority to the inflation target while enshrining the Bank of Israel’s de facto independence into law. The main monetary policy instrument is the Bank of Israel interest rate, which determines the overnight interbank rate.
The fiscal framework aims at ensuring fiscal discipline through annual deficit caps and long-term expenditure ceilings with a strong centralisation of responsibilities in the Ministry of Finance. Budgets are approved for one or two years, with a deficit ceiling for each year (and a revision in the second year) in the case of biennial budgets. Furthermore, since 2005, governments have been setting long-term expenditure ceilings to strengthen compliance with deficit targets while keeping in check the size of the government relative to the economy. Since the Stabilisation Programme of 1985 that followed hyper-inflation (see Box 1.4), the budget foundations and arrangements laws have given the Ministry of Finance greater control over the budget. Following a report by the State Comptroller, the Ministry of Finance in 2013 tightened the process for preparing the economic forecasts underpinning the budget including through the creation of a dedicated team within the Chief Economist’s Department.
Sources: (Brender, 2021[36]; Ribon, 2021[37])
Central Bank policy interest rate, estimated neutral nominal interest rate and effective exchange rate
Notes: A rising nominal effective exchange rate increase corresponds to the shekel appreciating against the currencies of commercial partners, weighed by their share in Israel’s foreign trade. The neutral rate shown on the chart is an exponentially smoothed time-varying illustrative estimate from a semi-structural latent-variable model where the difference between the observed real interest rate and a random-walk neutral real neutral rate influences variations in the unemployment rate. The observed real interest rate entering the model is the policy interest rate minus inflation expectations for the year ahead. The parameters are estimated by maximising the log-likelihood of the model computed with the Kalman filter initialised with parameter values obtained from a time-invariant specification. The illustrative estimate of the real neutral rate is obtained by exponentially smoothing the filtered path of the corresponding variable. The estimation is carried out over the period since the setting of the inflation target band. The illustrative estimated nominal neutral rate reported on the chart is obtained by adding exponentially smoothed (as in the model) inflation expectations to the estimated illustrative real neutral rate. Substantial uncertainty surrounds this estimate, which is therefore reported only for illustrative purposes.
Sources: OECD Economic Outlook: Statistics and Projections database and OECD calculations.
1.3.1. Financial markets have been remarkably resilient
Capital markets suffered limited losses in the immediate aftermath of 7 October 2023 followed by a rapid recovery. Even if geopolitical risk for Israel after 7 October increased in a manner unprecedented since the start in 1985 of Caldara and Iacoviello’s (2022[38]) so-called “recent” index, share prices fell by less than a tenth before bouncing back robustly (Figure 1.11 Panel A). Corporate bonds similarly recorded an increase in yields before easing (Figure 1.11 Panel B). The commercial real estate sector, which due to its heavy reliance on debt is vulnerable in times of high interest rates, has also withstood the shock of October 2023, with spreads rapidly returning to previous levels (Figure 1.11 Panel B).
This stability in the face of a very large geopolitical-risk shock reflects credibility in the monetary framework (see previous section), financial-system buffers (see below) and a relatively sound fiscal policy position going into the crisis (see fiscal section below), low private sector indebtedness, as well as deft crisis management. The Bank of Israel ensured currency stability by announcing on 9 October 2023 an open-ended pledge to sell up to USD30bn in foreign reserves, a credible amount since it represented less than one sixth of its holdings. The Bank of Israel supplied further liquidity by opening foreign-currency swap lines up to USD15bn. Further, the Bank of Israel on 16 October 2023 put in place programmes enabled vulnerable borrowers, including displaced people and categories of adversely affected businesses (especially among SMEs), to defer loan repayment.
Notes: The real share price index refers to the TAV100 deflated by the consumer price index. The geopolitical risk index for Israel measures is built using references to the country in major newspapers (Caldara and Iacoviello, 2022[38]).
Sources: OECD Financial Markets database; OECD Consumer Price database; Bank of Israel; and Caldara and Iacoviello’s (2022[38])’s updated database.
1.3.2. Banks need to maintain strong capital buffers
Capital buffers lay at the centre of the financial system and are a key source of overall financial stability and resilience. Among OECD countries, the Israeli banking system has capital buffers, relative to total assets, that are in the average, (Figure 1.12 Panel A). Capitalisation looks thinner when applying risk weights, but this partly reflects regulatory prudent and conservative choices with regards to risk weighting, which follows the standardised rather than internal-model approach (Figure 1.12, Panel B). Taking the example of housing loans, average risk weights are 53% and vary from 35% (when the loan-to-value (LTV) ratio is lower than 45% and the debt-service-to-income (DSTI) ratio below 40%) to 100% when the DSTI ratio is above 40% (CGFS, 2023[39]). By comparison, most EU-country banking systems operate with risk weights on housing loans that lie well below 15% (HCSF, 2019[40]).
The banking system’s resilience is underpinned by good loan performance (Figure 1.13). In mid-2024, non-performing loans (NPLs) stood at 0.8% of total loans, which is half the OECD average. When netted out of loan-loss provisions, thereby providing a more direct measure of capital depletion, NPLs amount to 4.5% of bank capital.
Supervisory policy has tools to keep fostering banking system resilience. Despite some decline in lending over deposit margins, banks produce very strong return on equity (Figure 1.13). This high profitability in part stems from reductions in operating costs, especially salary expenses, following productivity improvements (Bank of Israel, 2025[41]). The high return on equity may also reflect market concentration, as five banking groups hold 98% of total bank assets, highlighting the importance of the Bank of Israel Banking Supervision Department secondary objective of fostering competition (Chapter 4) alongside the primary goals of maintaining the stability of banks and credit card companies and a fair culture towards customers.
Notes: Risk weights in Israel are measured using the standardised approach while most other countries allow large banks to use internal models. No data point refers to before 2023.
Source: IMF Financial Soundness Indicators (FSI) database.
Banks’ solid financial performance offers a powerful way of buttressing capital buffers: supervisory authorities can require a minimum of profit reinvesting by capping dividend payments or share buybacks. The Supervisor of Banks in November 2023 required banks to follow a prudent and conservative approach when distributing dividends, after which banks reduced the share of their profits distributed as dividends. The potential risks that the Israeli financial sector is currently facing from geopolitical events, public debt accumulation and the construction downturn put a premium on continuing such supervisory action to ensure that banks retain a sufficiently high share of their profits.
Source: IMF Financial Soundness Indicators (FSI) database
1.3.3. Housing-related financial risks seem contained but continued monitoring is warranted
The macroeconomic risks from mortgage over-indebtedness appear limited for Israel at the current juncture. Outstanding housing loans are low by comparison with other OECD countries. This situation is favourable for both financial stability and long-term economic growth. The experience of OECD countries provides ample evidence that large household debt, especially linked to housing, is associated with greater financial instability and weaker economic resilience in the face of shocks (Caldera Sánchez et al., 2017[42]). Furthermore, too much household debt has shown able to slow long-term growth by magnifying the costs and distortions associated with implicit bank government guarantees, increasing vulnerabilities to shock and generating boom-bust cycles (Cournède, Denk and Hoeller, 2015[43]) as well as reducing the lending capacity available to fund non-financial firm growth (Bezemer et al., 2021[44]).
It is important to maintain the prudent macro-prudential policy framework and stance that have been in place since 2012-14, given that both have proven successful at keeping household debt in check. The current framework combines borrower and lender-based measures. On the borrower side, housing loan amounts are capped at 75% for principal residences, 70% for secondary homes and 50% for investment properties. Furthermore, debt service payments cannot exceed 50% of the borrower’s income. In addition, at least one third of the loan must be at a fixed interest rate. On the lender side, as previously mentioned, the authorities apply risk weights that are higher than in many other OECD countries.
Still, regular and careful monitoring is needed. Contractors are routinely marketing sales of new apartments through the provision of balloon loans (i.e. loans with low monthly payments and a large final payment) that buyers commit to repay upon delivery of the dwelling. Such arrangements involve a risk that a number of buyers may fail to repay the balloon loan at the time of completion, especially in the event of a downturn. The realisation of this risk could leave contractors with inventories of unsold apartments. Their difficulties can threaten lenders, who could in turn refrain from taking new real estate exposures or reduce their existing exposures, potentially triggering an adverse feedback loop. Bank capital provides a key source of protection against a potential negative feedback loop between developers and lenders, which reinforces the importance of encouraging banks to maintain strong capital buffers.
Notes: In Panel B, the data are for 2024Q3 in Canada, Israel, the United Kingdom and the United States and 2023Q4 in most other countries. No data point refers to earlier than 2023Q4.
Sources: Bank of Israel; OECD Economic Outlook: Statistics and Projections database; and OECD calculations.
1.4.1. Public finances have come under stress
The attacks and the conflicts have had far-reaching consequences for public accounts. The war and civil-defence effort required an increase in government consumption of more than 3% of GDP (Figure 1.15 Panel A). In addition, help for the evacuees from the areas around Gaza and northern areas bordering Lebanon required additional government expenditure in the form of transfers to hotels and families to pay for their accommodation, food and day-to-day expenses, for a total of around ⅓ percent of GDP from October 2023 to October 2024. The coverage of health care for survivors of the 7 October and rocket attacks amounted to 0.1% of GDP as of end 2024. Transfers worth 0.7% of GDP have been made to businesses whose activity was restricted by the war. Overall, the support put in place following the attacks and subsequent war amounted to 1.1% of GDP in the twelve months following October 2023.
Notes: In Panels A and B, the trend is estimated over 2014-2019. In Panel B, the series excludes social security contributions. In Panel D, general government debt data for 2024 refers to projections.
Sources: Israel Central Bureau of Statistics (CBS); OECD Economic Outlook: Statistics and Projections database; OECD National Accounts database.
Government revenue, which contracted immediately after 7 October 2023, has recovered. Shop closures and reductions in production dented value-added and income-tax receipts. However, the consumption-led rebound in economic activity that started from the end of 2023 has ensured a tax-rich recovery with receipts going above their long-term trend (Figure 1.15 Panel B). Another important source of revenue has been US military assistance of 1.7% of GDP in 2024, compared with an annual average of 0.8% of GDP over 2017-2021.
1.4.2. Fiscal authorities have relied on a mix of deficit financing, revenue increases and spending restraint
Fiscal authorities decided to fund the jump in spending in part through public borrowing while also introducing revenue and spending measures (Figure 1.15, Panel C). On the revenue side, a key measure is the one percentage point VAT increase, which should bring in 0.4% of GDP in additional revenue per year. On the spending side, the main adjustment measures in 2024 comprised across-the-board cuts in the discretionary spending of line ministries, reductions in the public-sector wage bill including through a hiring freeze, and the cancellation or suspension of a number of investment projects.
The widening of the budget deficit and greater perception of country risk since October 2023 contributed to a rise in borrowing costs (Figure 1.15 Panel D). The effects are visible in the sharp rise in October 2023 in the CDS premium for insuring Israeli government bonds against default (Figure 1.16). Other powerful drivers of the run-up in long-term government bond yields after 2022 were the rise in short-term interest rates and inflation (see section on monetary policy). Investor concerns regarding medium-term fiscal prospects have also been reflected in decisions by credit rating agencies Fitch, Moody’s, and Standard & Poor’s. All three credit rating agencies are keeping Israel on negative outlook. CDS premia and government bond yields declined in December 2024 and January 2025 following geopolitical and fiscal policy advances. The ceasefire with Lebanon and advances in negotiations towards the release of hostages in Gaza resulted in a downward reassessment of geopolitical risk. Furthermore, the Knesset (Parliament) passed first and second readings of several fiscal consolidation measures.
Notes: The Credit Default Swap (CDS) premium is the price of insuring a bond against default. In Panel A, the vertical square dotted line indicates the date of 7th October 2023.
Sources: OECD Economic Outlook: Statistics and Projections database; LSEG; and OECD calculations.
1.4.3. Near-term fiscal policy must keep sovereign risk in check without undercutting near-term growth
The fiscal policy stance must be carefully balanced. Government indebtedness is well below the levels observed in many OECD countries. However, comparatively high geopolitical risk means that stronger buffers against shocks are needed. In addition to risk management, there is also a budgetary case for fiscal prudence allowing to keep debt levels and risk premia in check. Fiscal consolidation should give priority to measures that are most compatible with long-term growth while avoiding very rapid and deep adjustment as long as elevated geopolitical tensions weigh on private demand and international business linkages.
A permanent and credible consolidation favouring growth-friendly measures maximises the risk-premium reduction for a given size of adjustment. Many adjustments planned for 2025 follow this logic with the introduction of new fiscal measures such as the carbon tax and the one-percentage-point increase in the VAT rate, which are welcome. Both environmental and consumption taxes have low effects on long-term growth prospects compared with other taxes, making them particularly efficient tools for fiscal consolidation (Cournède, Fournier and Hoeller, 2018[45]). The new tax on undistributed accumulated profits of closely held companies is also set to provide a steady stream of revenue. The increase in social security tax will also bring a permanent improvement in revenue although at the cost of raising the tax wedge on labour. The 2025-2026 freeze in tax brackets is also designed to bring a permanent increase in revenue, as indexation is planned to restart only in 2027 without compensating for the lack of adjustment in 2025-2026.
1.4.4. Fiscal policy should adjust to meet long-term challenges
As the conflicts ease, the fiscal position will improve but remain challenging. As the geopolitical situation continues to improve, military spending will fall back to its new level, 0.9% of GDP above pre-October-2023 levels. Before that, one-off expenses will be incurred to replenish stocks and replace equipment. In addition to that, the rehabilitation of damaged infrastructure and post-conflict treatment of veterans and civilian victims, including mental-health care, will require additional expenditure, which may be in the order of 0.5% of GDP over around half a decade. Together with the permanent budgetary adjustments made in 2024-2025, this implies an estimated general government primary surplus below 0.1% of GDP in 2027. The deficits incurred in 2023-2026 are set to bring public debt from 60% of GDP end 2022 to around 69% end 2026: in an environment of higher interest rates than the previous decade, this change implies higher debt service costs.
This anticipated medium-term fiscal position without additional adjustment would put public debt on a trajectory leaving insufficient cushion against risks (Figure 1.17). Such a long-term debt outlook would be sub-optimal in Israel, given a higher sovereign risk premium than most countries with similar or lower public debt-to-GDP ratios, on account of elevated levels of geopolitical risk. In this environment, it would be advisable to aim for keeping public debt below 60% of GDP as was achieved ahead of the COVID-19 crisis. In addition, there is a need to leave room for the increase in expenditure that would follow from removing obstacles to public investment and closing public-infrastructure gaps (see growth section above) while preparing for the needs of a fast-growing population. Besides, the assumptions behind this trajectory do not include negative impacts from climate change (such as post-disaster costs and revenue losses) as well as spending on mitigation and adaptation beyond current levels.
The country has limited space for substantial spending cuts. In typical situations, expenditure-based fiscal consolidation better preserves economic prospects, as a smaller government size is generally associated with higher trend growth across most OECD countries (Fournier and Johansson, 2016[46]). In the case of Israel, however, the low level of non-defence public expenditure limits the leeway for spending reduction. The government spends comparatively little, as a share of GDP, on health and social protection (Figure 1.18). Education expenditure per student is also low while average education outcomes and skills are below the OECD average (Koelle, 2023[9]).
There is some scope to raise revenue while limiting adverse effects on activity. Israel has a relatively low aggregate tax-GDP ratio by comparison with other OECD countries (Figure 1.19). Most tax instruments bringing revenue below or near OECD averages (Figure 1.19). After it increased to 18% in January 2025, the standard rate of value-added tax (VAT) remains below the average among other OECD countries that implement this tax (19.3% in 2024). By contrast with many other OECD countries, there is no reduced VAT rate in Israel. Exemptions (including in the form of zero-rating) however apply to a number of products such as fruit and vegetables, inward foreign tourism, clothing and other shopping items purchased in Eilat. Closing VAT exemptions offers potential for additional revenue generation with more limited effects on long-term growth prospects than most other tax instruments (Akgun, Cournède and Fournier, 2017[47]).
The carbon tax can also be a vehicle for income generation as well as further environmental progress. Currently planned rates are very low per tonne of carbon dioxide (CO2). Aligning planned rates for 2030 with EUR60 per tonne of CO2, the mid-point of the benchmark rate for mitigation efforts in the OECD (2023[48]) would imply a more than threefold increase in the rate on natural gas. Besides bringing in 0.25% of GDP in extra revenue per year, such a reform would sharpen incentives to deploy carbon-free sources of power generation.
Another important dimension of fiscal reform is to prepare for the gradual fall in fuel tax revenue from the decarbonisation of the economy especially the take-up of electric vehicles. Current fiscal arrangements involve hiking car registration taxes. The authorities are also considering the introduction of a mileage tax, which would offer the benefit of being more directly linked to the budgetary and social costs from road use and congestion. In addition, a mileage tax is fiscally more reliable, as it is untied to cyclical fluctuations in car purchases. Finally, a mileage tax avoids the incentive that high registration taxes create to keep older, more polluting, more dangerous cars on the road. Besides, congestion charging could be deployed, starting in Tel Aviv.
Illustrative general government debt scenarios, % of GDP
Notes: The “Unchanged policies” scenario follows the OECD Economic Outlook 116 database until 2026. Subsequently, following permanent tax and spending changes and the assumption of rehabilitation expenditure of 0.5% of GDP for five years, the primary balance in the “Unchanged policies” scenario starts from a surplus below 0.1% of GDP in 2027 before evolving on account of trend changes in health and pension outlays as well as employment. More specifically, health and pension spending rise according to the profiles in the long-term baseline database of the OECD Economic Outlook No. 116. Potential employment in this scenario evolves according to the assumption that new cohorts have, by population group, the same participation rates as current ones (corresponding to the “unchanged participation rates” scenario in (Box 1.1)
The “Fiscal reform” scenario incorporates higher public investment (+0.7% of GDP to bring the public-sector capital stock to the OECD average by 2040 then +0.3% over 2040-2060) and the tax increases listed in Table 1.6 as well as the GDP impact of higher public investment.
The “fiscal and structural reform” scenario includes increases in trend employment and GDP from the structural reforms described in Box 1.3 and higher public investment. More specifically, employment follows the scenario of “new progress at past pace” described in Box 1.1
Sources: OECD Economic Outlook 116 database; OECD Long-Term Model database; and OECD calculations
Taxes can also be introduced that improve economic, social and environmental outcomes while bringing revenue. One example is the taxation of unused developable land which encourages construction in areas where it is desirable from an urban-policy perspective. As discussed in Chapter 4, such a tax could be introduced alongside the taxation of rental income and a recalibration of recurring property taxes while shifting away from transaction taxes. A real-estate-taxation reform package of this nature could bring additional revenue while improving tax efficiency. Another example are taxes on sugary drinks and single-use items, which can contribute to improving human health and the environment respectively.
Note: Panel A, for IRL as % of GNI.
Sources: OECD National Accounts database; OECD Education at a glance database; OECD Economic Outlook: Statistics and Projections database; and OECD calculations.
Taken together, the above tax reforms would allow to fund a substantial increase in public investment while putting public debt on a path towards reaching by 2035 similar ratios to GDP as the ones that prevailed before COVID-19 and before 7 October 2023 (“fiscal reform” scenario on Figure 1.17 and Box 1.6). Furthermore, implementing the above-mentioned reforms (see growth section) to foster stronger core-curriculum skill acquisition and greater labour market participation across every Israeli community would lastingly increase employment, considerably improving the long-term fiscal-sustainability outlook (Figure 1.17).
Spending reviews provide a potentially powerful tool to improve efficiency and reduce expenditure on areas or programmes where benefits are not commensurate with costs and current priorities. Spending reviews have in the past been narrow in scope in Israel, covering below 5% of government expenditure (OECD, 2023[4]). Conducting reviews on broader areas of expenditure would magnify the potential for identifying overlaps (Tryggvadottir, 2022[49]). To enhance their benefits, the spending reviews should be tightly integrated in the budget process (Tryggvadottir, 2022[49]).
Notes: The OECD aggregate is an unweighted average of the countries in the group. Panel A, 2022 for Australia and Japan and as % of GNI for Ireland. Panel B, environmental related taxes data for Israel refers to 2021, while to 2022 for the OECD.
Sources: OECD Global Revenue Statistics database; and OECD Environmentally related tax revenue database.
Trends 2024: VAT/GST and Excise, Core Design Features and Trends, OECD Publishing, Paris, https://doi.org/10.1787/dcd4dd36-en.
A strong fiscal framework is key to achieving the size of the required fiscal adjustment in a long-lasting way while supporting long-run growth. Fiscal policy has a proven track record of prudence in Israel over the past two decades, but there has also been experience of frequent adjustments in expenditure ceilings. Previous Surveys have recommended strengthening fiscal frameworks (Table 1.7). Adjustments in medium-term plans, which may be needed especially in an environment as volatile as Israel’s, can be compatible with credibility if they are undertaken when certain pre-defined conditions are satisfied rather than on a discretionary basis (Moretti, Keller and Majercak, 2023[50]). The on-going programme to improve official long-term fiscal projections offers a welcome way of further anchoring the credibility of the fiscal framework (Box 1.7).
Table 1.6 presents illustrative fiscal impacts of recommendations with substantial spending or revenue implications. The results are indicative. They exclude feedback effects from behavioural responses, except the government revenue gain from the recommended structural reform package through higher employment. Particularly strong uncertainty is attached to the future revenue gains resulting from reforms anticipated to boost employment: consequently, fiscal authorities should wait until these revenue gains have materialised before factoring them into spending decisions.
Fiscal saving (+) and costs (-) after 15 years
Note: (1) The employment rate by 2.3 percentage points in 2040 relative to the “unchanged policies” scenario.
Source: OECD calculations based on the OECD Long-Term Model.
No official body in Israel regularly conducts and publishes projections on how the main fiscal expenditures and aggregates evolve in the long run if current laws remain unchanged. This contrasts with the situation in most OECD countries. As of 2018, 26 out of 34 OECD countries surveyed in the OECD Budget Practices and Procedures Survey reported that they produce long-term fiscal sustainability reports. The absence of such analysis limits the ability of the Israeli fiscal institutions to incorporate the long-term implications of economic decisions. Making policymakers aware of these implications is crucial for tackling structural challenges and ensuring that the government can avoid sudden and difficult corrections to the balance of income and expenditures. Previous Surveys had stressed the importance of systematically conducting long-term fiscal sustainability analysis.
The OECD is supporting the Ministry of Finance in defining key trends such as population ageing affecting the volume of public expenditures in the long run and developing a model that examines the impact of these trends on budget expenditures, deficit and debt-to-GDP under different policy scenarios up to 2065. The model in development focuses on education expenditures, social transfers to the elderly and the working-age population, pensions, health expenditures, public infrastructure investment and interest payments. The model relies on previous work conducted by the OECD Economics Department on long-run economic and fiscal projections (Guillemette and Château, 2023[22]) with adjustments to include Israeli-specific trends, such as the rapid increase of population groups with comparatively weak labour-market attachment and human-capital accumulation.
Source: (OECD, 2025, forthcoming[12])
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