Is Operation Protective Edge going to be Israel’s most expensive war of the decade?

It depends whom you ask. Defense officials said that as of Wednesday at midnight, the cost of Protective Edge had passed 9 billion shekels ($2.5 billion) after 41 days of fighting, exceeding the bill of the 34-day Second Lebanon War in 2006 by some 800 million shekels – and Protective Edge isn’t over yet. On the other hand, the army has spent less per day battling Hamas than Hezbollah: Spending on the Lebanon War averaged 240 million shekels a day (based on the shekel’s value at the time) while Protective Edge has averaged 210 million shekels daily.

In any case, treasury officials are not convinced the costs are that high, and say the real spending to date on Protective Edge is nearer 7 billion shekels. In any case, sources in both the finance and defense establishments say the daily cost has dropped since Israel withdrew its troops from Gaza.

Defense sources told TheMarker that the discrepancies between the cost estimates are apparently because their estimate includes the cost of repairing damaged military systems, as well as for restoring units to full battle-readiness before being stored away for the next emergency. That alone will run to more than a billion shekels. There’s also the cost of caring for the wounded and the families of soldiers who died in battle. The army suspects that the Finance Ministry’s calculations leave out all of that.

Moreover, even after Israel ended ground operations, the army has been spending heavily on reserves and logistics. Putting one soldier on reserve duty costs the government about 500 shekels a day on average, and that’s without including his “military” costs. Right now some 60,000 reserve soldiers have been called up, which is costing the government 30 million shekels a day. Over a month, that comes to almost a billion shekels.

The final cost of the war is more than a matter for the Guinness Book of World Records. The issue of defense spending was already a matter of serious dispute before the fighting broke out, with the army demanding an extra 10 billion shekels for its budget in 2015, jacking up its total net budget to 62 billion for the year. Its gross budget, which includes “income-contingent items” such as income from arms sales, would have passed 70 billion shekels.

Subjugated to defense?

The army’s spending demands are so big that treasury officials fear that the budgets over the next three years will be subjugated to military needs at the expense of civilian spending. The problem is made worse by concerns that tax revenues will be smaller than expected amid signs that the economy is slowing. Those concerns become all the more acute if Israel enters into a war of attrition with Hamas, which would both debilitate the economy and increase defense costs.

Finance Ministry sources say they can’t possibly beef up the defense budget by as much as the army is demanding. They say the defense establishment has to streamline and undertake structural changes that altogether should yield savings equal to the extra spending it wants. The defense establishment says Prime Minister Benjamin Netanyahu will have to mediate, which should work in its favor.

Finance Ministry sources say that if the defense establishment really does get a big budget increase next year, the money will have to come from deep, painful cuts in education, health care, welfare and infrastructure because there are no reserves in the budget. In other words, the entire budget would take a back seat to defense. And it could well be that the bite out of civilian budgets won’t end in 2014 and 2015, but continue into 2016, they say.

The Finance Ministry is wrapping up its 2015 budget proposal to present to the prime minister next week. The cabinet will start discussing it in early September, two months behind schedule.

Treasury officials are thinking of bringing back the old cap on how much the budget may grow from year to year, as was done for the 2013 and 2014 budgets. Under the present cap, the 2015 budget may grow by 2.6%, compared with the 2014 budget, but under the old one, it could grow by 3.5%. The difference works out to 10 billion shekels, which would greatly help treasury officials finalize the budget for 2015. It remains to be seen whether Finance Minister Yair Lapid will accept the old cap, which had been set under his predecessor, Yuval Steinitz.

The treasury is also fretting about a collapse in tax revenues if the fight with Hamas turns into a war of attrition. The ministry has already lowered its tax revenues estimate for 2014 from between 273 billion and 276 billion to 268 billion, and will probably lower it again.

Moreover, in the face of wall-to-wall opposition from the Finance Ministry and Bank of Israel economists, Lapid is insisting on going ahead with his plan to eliminate the value-added tax on new homes purchased by eligible buyers, even though it will reduce tax income by 3 billion shekels next year.

In the meantime, treasury officials have come up with an alternative to raising taxes – which Lapid has vowed not to do – namely, to raise the 2015 deficit target from 2.5% of gross domestic product not to, say, 2.95% or even 3%, as the treasury had planned to do anyway, but to 3.5%. That would give the ministry another 10 billion shekels to work with. The Bank of Israel won’t say a word against the idea, on condition that their analysis shows the budget deficit being cyclical, not entrenched.

Another source of income for the government would come from canceling or at least scaling back tax breaks, which reached 44.3 billion shekels in 2014, or 19% of anticipated tax revenues this year. It’s also equivalent to 4.5% of Israel’s GDP. A courageous political move backed by the coalition could reduce that sum by more than 10 billion shekels.

