OECD Economic Surveys: Israel 2023

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OECD Economic Surveys: Israel

3 April 2023

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1. Key policy insights

Abstract

Israel’s economy recovered swiftly from the pandemic and has proven resilient to the repercussions of Russia’s war of aggression against Ukraine. Inflation has risen above the central bank’s target range amid strong demand and a tight labour market. In response, monetary policy has been tightened. Fiscal policy has consolidated and should remain neutral to not add to inflationary pressures. In light of demographic challenges and much-needed investment to boost productivity and narrow socio-economic gaps, ensuring fiscal sustainability will require a medium-term fiscal strategy and an enhanced fiscal framework. To maintain the good overall health outcomes, emerging doctor shortages need to be addressed and the interaction between the public and private health care sector reformed. Reducing digital gaps across households and firms, by improving digital infrastructure, skills, competition and reducing financing constraints, can boost productivity growth and narrow the productivity divide between the high-tech sector and the rest of the economy. Fully harnessing Israel’s solar energy potential can help accelerate the green transition.

The economic recovery from the COVID-19 pandemic is well advanced and has proven resilient to the repercussions of Russia’s war of aggression against Ukraine. Substantial fiscal and monetary measures were rolled out swiftly and supported the health system, households and businesses during the pandemic. One of the fastest vaccination campaigns in the world helped mitigate the health impact and allowed to open the economy earlier than in other OECD countries. The buoyant high-tech sector drove Israel’s strong recovery. GDP rebounded quickly after the COVID-19 shock and surpassed its pre-crisis trend in 2021 (Figure 1.1). Growth remained strong in 2022. The labour market has recovered and is tight despite some recent easing. The war in Ukraine impacts the economy mainly via lower demand from trading partners and adds to inflationary pressures, although Israel’s self-sufficiency in natural gas is a mitigating factor. Global and domestic uncertainty is elevated.

Figure 1.1. The economy has been resilient

Addressing Israel’s structural challenges is crucial to sustain progress in living standards. The country remains a two-speed economy, with its highly productive high-tech sector on the one hand, and low productivity traditional sectors, which employ most of the workforce, on the other hand (Figure 1.2). This divide holds down aggregate productivity convergence (Figure 1.3). In order to boost aggregate productivity, barriers that hinder the high-tech sectors’ expansion should be removed, and the productivity of poorly performing sectors lifted. This will require addressing longstanding weaknesses in educational outcomes, low private investment, including in digital technologies, in traditional sectors, lagging infrastructure investment and barriers to competition.

Socioeconomic gaps remain wide. The duality in the business sector contributes to large labour market inequalities. Certain groups, especially the Haredim (ultra-Orthodox Jews) and Arab-Israelis, are underrepresented in the thriving high-tech sector, and have low employment rates, working hours and wages. For Haredi men, this also reflects an explicit choice to focus on non-material benefits and engage in life-long religious studies. As a result, income inequality is wide, and poverty remains an important concern (Figure 1.4). Moreover, with the population share of Haredim and Arab-Israelis projected to increase from currently around 30% to 50% in 2060, labour market integration is vital for growth and fiscal sustainability. While health outcomes are good overall, they are much weaker for Arab-Israelis, and the pandemic has exposed strained resources in the health care sector. High air pollution adds to health concerns and carbon emissions are still a long way from targets.

Figure 1.2. Israel is a two-speed economy

Value added per worker in the business sector, thousand USD PPP, 2018

Figure 1.3. Aggregate productivity convergence has been slow

Productivity gap to the OECD upper half, %

Figure 1.4. Poverty is high and socioeconomic gaps remain wide

Relative poverty, %, 2019 or latest available year

Against this background, the main messages of the Survey are:

Monetary conditions should remain tight and the fiscal policy stance should be neutral to not add to inflationary pressures, while maintaining flexibility to react to risks and uncertainty through temporary and targeted support if needed. Ensuring fiscal sustainability while allowing for productivity-enhancing investment calls for further efforts to enhance spending efficiency, increase tax revenues and strengthen the fiscal framework.
Fostering productivity and more sustainable and broad-based growth requires further measures to accelerate the green and digital transitions and to reduce the wide digital divide, including through policies to promote product market competition, strengthen private investment incentives and better price the environmental impacts of economic activity.
Reforms to enhance labour market participation, improve skills, foster labour mobility and address labour shortages in the high-tech and health care sectors are needed to address demographic challenges, and can improve equality of opportunity, reduce socioeconomic gaps, sustain growth and ensure fiscal sustainability.

Economic growth is robust but risks are elevated

After a relatively mild GDP downturn in 2020 (1.9%), the economy recovered strongly in 2021 (8.6%). The vibrant high-tech sector, which accounts for more than 15% of GDP, proved to be particularly resilient, thanks to its ability to shift to telework more easily and government policy to facilitate the activity of high value-added sectors during the lockdowns. The sector also benefitted from increased demand especially for software products. High-tech sector exports continued to grow strongly throughout the crisis, making up over half of total exports. Employment increased strongly, and accounts for around 12% of total employment. However, in 2022 the sector faced some headwinds from the pronounced decline in stock markets, especially for technology stocks, in Israel and the United States, where many Israeli high-tech firms are listed.

Economic activity remains robust, and the labour market is tight, although recent data indicate some easing. Overall, growth was strong in 2022, at 6.4%. Confidence in the business sector remained positive in early 2023. The labour market has recovered and is tight, with employment rates in most sectors around or above pre-pandemic levels (Figure 1.5). Despite some decline in recent months, the high vacancy rate suggests continued strong labour demand. The unemployment rate has increased somewhat in the second half of 2022. The tight labour market is leading to robust nominal wage growth. However average real wages have moderately declined in recent months.

The war in Ukraine has put pressure on global energy and food prices, although energy price effects in Israel are more limited given the country’s self-sufficiency in natural gas. Regulated electricity prices were increased by 8.6% in August 2022 and again by around 6.5% in early 2023 due to increasing costs of imported coal used in electricity generation. In the medium term, an expansion of natural gas exports in particular to Europe may support growth. Israel has discovered several major offshore natural gas reserves in the past decade. Natural gas accounts for around 40% of total energy supply. In 2021, the country produced about 20BCM and exported around 7BCM to Egypt and Jordan. Gas production and exports increased in 2022. Gas exports and reduced imports have increased GDP growth by around 0.2-0.3 percentage points in recent years (OECD, 2020[1]). Israel, Egypt and the EU have signed an agreement in June 2022 to boost gas exports to Europe likely via LNG terminals in Egypt, which will require additional investment in the pipeline and LNG infrastructure. Direct trade volumes with Russia and Ukraine only accounted for around 1% of total trade before the war. Russia’s war against Ukraine may also boost defence exports in the medium term.

The war has led to a significant increase in immigration. In 2022, around 58 000 (0.6% of the population) new immigrants from Ukraine (about 16 000) and Russia (42 000) arrived in Israel, a significant increase over previous years. Most of the immigrants are Jewish, which entitles them under Israel's Law of Return to immediate citizenship. In addition, the strong labour market and Israel’s experience with large waves of immigrants in the past is likely to facilitate integration of the immigrants.

GDP is projected to grow at a robust, albeit more moderate, pace in 2023 and 2024 (Table 1.1). The global slowdown will lower demand from Israel’s trading partners. Elevated inflation is weighing on real disposable income and private consumption growth. The increase in real interest rates and high uncertainty is set to slow investment. The labour market will slightly cool as growth moderates. Inflation should gradually slow towards the mid-point of the central bank target, supporting a pickup in domestic demand in 2024.

	2019	2020	2021	2022	2023¹	2024¹
	Current prices (NIS billion)	Annual percentage change, volume (2015 prices)
Gross domestic product (GDP)	1434.6	-1.9	8.6	6.4	3.0	3.4
Private consumption	751.1	-7.9	11.1	7.7	3.5	4.1
Government consumption	316.5	2.8	4.2	0.6	1.9	1.2
Gross fixed capital formation	325.0	-3.9	11.7	9.3	4.8	4.6
Housing	94.0	-7.8	13.7	16.6	5.1	1.3
Final domestic demand	1392.7	-4.5	9.5	6.5	3.5	3.6
Stockbuilding²	9.7	1.2	0.5	1.0	0.2	0.0
Total domestic demand	1402.3	-3.3	9.9	7.4	3.6	3.5
Exports of goods and services	420.3	-2.7	14.6	8.0	1.0	3.2
Imports of goods and services	388.0	-8.1	20.6	11.7	1.2	3.4
Net exports²	32.3	1.4	-0.8	-0.7	0.0	0.1
*Memorandum items*
Potential GDP	. .	3.7	3.7	3.8	3.9	4.0
Output gap (% of potential GDP)	. .	-4.1	0.4	2.8	1.9	1.4
Employment	. .	-1.4	1.1	5.8	1.5	1.6
Unemployment rate (% of labour force)	. .	4.3	4.9	3.8	4.3	4.3
GDP deflator	. .	1.0	2.2	4.6	3.2	1.8
Index of consumer prices	. .	-0.6	1.5	4.4	3.8	2.2
Index of core inflation³	. .	-0.1	1.2	4.0	3.8	2.2
Current account balance (% of GDP)	. .	5.4	4.3	3.7	4.2	4.0
General government fiscal balance (% of GDP)	. .	-10.8	-3.7	0.3	-0.9	-1.1
Underlying general government fiscal balance (% of potential GDP)	. .	-8.5	-3.9	-1.0	-1.8	-1.8
Underlying government primary fiscal balance (% of potential GDP)	. .	-6.8	-1.3	1.5	0.4	0.4
General government debt (% of GDP)	. .	71.7	68.9	61.0	58.5	56.8
General government net debt (% of GDP)	. .	67.6	65.1	58.2	55.7	54.0
Three-month money market rate, average	. .	0.1	0.0	1.0	4.2	4.5
Ten-year government bond yield, average	. .	0.8	1.1	2.6	4.2	4.3

1. OECD projections.

2. Contribution to changes in real GDP.

3. Index of consumer prices excluding food and energy.

Source: OECD Economic Outlook Statistics and Projections database. OECD Annual National Accounts database.

Risks are skewed to the downside. A prolonged conflict in Ukraine could adversely affect the economy via lower demand from trading partners and a re-intensification of pressures in global energy markets leading to higher inflation. Higher global and domestic interest rates could lead to increased volatility in financial markets. An increase in uncertainty or security incidents could weigh on business sentiment and investment. The effects of more shocks are discussed briefly in Table 1.2.

Shock	Possible impact
Global energy, food or raw material shortages.	A very cold winter and higher competition for LNG as China recovers from the Zero-Covid policy slowdown could lead to energy shortages in Europe. An intensification of global energy, food and raw material supply disruptions would lead to a further acceleration of inflation and a contraction of global trade, leading to stagflation.
Major house price correction	A large fall in house prices would adversely affect residential investment and consumption through wealth effects with possible spillovers to the labour market. Vulnerabilities in the banking sector due to its strong exposure to the real estate market could be exposed.
Outbreak of a new vaccine-resistant COVID variant	Further waves of infections could potentially lead to new containment measures and lower domestic spending.
Heightened geopolitical tensions	Geopolitical instability in the region would increase uncertainty and weaken both domestic and external demand, with negative budgetary repercussions.

Monetary policy has been tightened

Inflation has increased above the central bank’s 1-3% target range but remains lower than in most OECD countries (Figure 1.6). In February 2023, headline consumer price inflation stood at 5.2% and core inflation (excluding energy and food) at 5.0%. The increase was driven at first mainly by global factors such as supply bottlenecks and surging energy prices. However, inflation has become more broad-based as the economy recovered rapidly from the pandemic and the labour market tightened. The trend currency appreciation has mitigated inflationary pressures in 2021, but the exchange rate has become more volatile in 2022 and early 2023. Short-term inflation expectations are around the upper bound of the inflation target. Medium- to long-term inflation expectations edged up to around 2.5%, above the mid-point of the target range.

Tight monetary policy conditions should be maintained to bring inflation back into the target range. With inflation and inflation expectations rising significantly in 2021, real short-term interest rates became deeply negative. In response, the Bank of Israel first ended all quantitative easing measures by the end of 2021. Quantitative measures included the purchase of government and corporate bonds and the extension of long-term loans to SMEs via the banking sector. These measures have expanded the central bank’s balance sheet by around 8% of GDP. In addition, the central bank ceased to intervene in the foreign exchange market and raised the policy rate eight times between April 2022 and February 2023, from 0.1% to 4.25%. With inflation above target and robust domestic demand, maintaining a tight monetary policy stance is warranted. The central bank has signalled that the pace of further interest hikes will be determined based on inflation and activity developments. If underlying inflationary pressures become more pronounced, the central bank could also actively reduce its balance sheet in combination with further policy rate increases.

The case for foreign exchange interventions to mitigate appreciation pressures has diminished. The central bank has at times operated in the foreign exchange market mainly to counter appreciation pressures, when these were judged to be excessive. Foreign currency purchases were significantly stepped up in 2020 and 2021 (in total around USD 56 billion). The interventions aimed to mitigate deflationary pressures from the sharp currency appreciation, at a time when inflation was below target, and to smooth the adjustment in the tradeable sector. Foreign exchange interventions can be an appropriate monetary policy tool when the policy rate is at the effective lower bound and deflationary pressures from currency appreciation threaten to de-anchor inflation expectations. With the policy rate no longer at the lower bound, inflation above target, a significant current account surplus and ample foreign currency reserves (37.5% of GDP), the case for foreign exchange intervention is limited and market forces should be allowed to determine the shekel exchange rate as long as the market functions properly. Indeed, the central bank stopped foreign exchange purchases before the policy rate lift-off, and has not purchased foreign currency since January 2022. In addition, the sovereign wealth fund has become operational in 2022, and will invest abroad the proceeds from a special levy on the profits of the gas and minerals industries. This should reduce trend appreciation pressures, albeit to a very limited extent given the expected small inflows into the fund in the next few years.

Figure 1.6. Inflation has increased above the target

Financial market risks should be monitored

The financial authorities have reversed most of the pandemic easing measures as credit growth resumed at a strong pace in 2021. Reductions in loan-to-value ratios and bank capital requirements expired at the end of 2021. The loan service payment deferral programme ended in March 2021, with deferred loans accounting for only around 1% of total loans at the end of 2021. Credit growth, especially mortgages, started to moderate somewhat in the second half of 2022 due to tighter monetary and financial conditions. Private sector debt has increased in the past decade, driven in particular by household mortgages and credit to the construction and real estate sectors (see below). Nevertheless, with non-financial business sector debt at around 69% of GDP and household debt at around 43% of GDP in June 2022, private sector debt is still relatively low in international comparison.

The banking sector appears sound. Profitability has increased and non-performing loan ratios remain low (Figure 1.7). Capital ratios are slightly below their pre-crisis levels but continue to comfortably surpass regulatory requirements. Stress tests suggest that even under an extreme scenario, including a sharp slowdown in economic activity, asset market declines and increases in interest rates and inflation, the capital ratios of all banks would remain above regulatory minima (BOI, 2022[2]).

Figure 1.7. The banking system appears sound

Risks from the housing market should continue to be closely monitored. House price growth resumed strongly from the second half of 2020, outpacing growth of rents significantly (Figure 1.8). Banks are heavily exposed to the real estate market, with more than half of total loans directed to this sector (Figure 1.8). A relatively conservative macroprudential approach, including limits to mortgage loan-to-value ratios (75%), to payment-to-income ratios (50%), and to the banks’ exposure to the construction and real estate sectors, together with higher risk weights for high-risk loans and additional capital requirements for housing loans, reduces risks to financial stability from the real estate market. However, the share of higher-risk mortgages has edged up, with loans with a debt service-to-income ratio of above 30% accounting for around 45% of new loans in mid-2022. In addition, about three-fourth of the value of all mortgages will be affected by higher interest rates and/or inflation due to variable interest rates and/or inflation indexation. The authorities should therefore remain vigilant and adjust macroprudential measures if needed.

Financial market supervision is conducted by the Bank of Israel, the Capital Markets, Insurance and Savings Authority and the Securities Authority. In late 2018, these three institutions together with the Ministry of Finance established a Financial Stability Committee to enhance supervisory co-ordination. The Israeli banking sector has long been dominated by five banks, with the largest two holding more than 50% of all assets. Regulatory measures to reduce switching costs and facilitate entry of new financial institutions, including fintech companies have had some success in reducing market concentration. For example, a new online bank started operations in 2021 and the share of non-banks in consumer credits has increased from 12% in 2013 to 29% in 2021. However, competition in other credit segments is still low, with credit to small businesses almost exclusively provided by banks (BOI and MOF, 2021[3]). Several recent reforms and developments have the potential to facilitate new entries, including of fintechs, and foster greater competition. In 2022, a new law came into effect as part of the open banking reform that requires banks to share customer information (e.g. current account and credit card charges) with competitors, subject to the customer’s consent. In addition, the central bank plans to expand the credit data register to include corporate credit data, and measures have already been taken to enhance transparency in the mortgage market. Following a government decision, a committee to review the financial supervisory structure and foster competition and innovation was established but then dissolved without agreed conclusions. Going forward, it will be important to find an adequate balance between facilitating financial innovation and competition, for example through regulatory sandboxes for fintechs, while leaving no gaps in financial supervision and ensuring the continued safety of the financial system.

Figure 1.8. The real estate market poses risks

Addressing short and long-term fiscal policy challenges

The government budget balance has improved considerably in 2021 and 2022 thanks to the phasing out of pandemic support and strong revenue growth (Table 1.1). Public debt is estimated to have fallen to around 61% of GDP at the end of 2022, slightly above pre-pandemic levels. Pandemic-related direct fiscal support was reduced from around 5.7% of GDP in 2020 to 3.7% in 2021, and less than 1% of GDP in 2022. Most household and firm support measures were phased out in mid-2021, while remaining support is mainly channelled to health. At the same time tax revenues grew strongly (by over 2 percentage points of GDP from 2020 to 2021) due to the strong economic rebound and some exceptional factors. Around half of the revenue growth was due to exceptional factors related to high financial and real estate valuations, strong import growth as well as increased profits in the high-tech sector (BOI, 2022[4]). Revenue growth remained strong in most of 2022 but started to slow towards the end of the year. Going forward, revenue growth is likely to further slow as the recovery moderates and some transitory factors, related to high real estate valuations and surging corporate profits, dissipate.

The fiscal policy stance should be neutral to not add to inflationary pressures while maintaining flexibility in light of the uncertainty surrounding the outlook. The authorities took a number of temporary measures in 2022 to mitigate the increase in the cost of living. This included expanding the earned income tax credit and child tax allowances, reducing the excise taxes on coal and transport fuels and reducing some custom tariffs and non-tariff import barriers (see below) on a number of goods, including foods. The estimated fiscal cost of these measures is around 0.7% of GDP in 2022. Additional support to the most vulnerable households may be needed if inflation proves persistent, but should be well targeted and temporary so as not to add to inflationary pressures. The expansion of child tax allowances and the reduction of the coal excise tax have been extended until end-2023, and the reduction of the excise taxes on gasoline until end-2024. The coal and gasoline price support measures are not well targeted and should be temporary as planned. Moreover, energy price support needs to be carefully designed to ensure it does not weaken incentives to reduce energy consumption. Reforms to reduce tariff and non-tariff import barriers are welcome and should continue as they can reduce the cost of living as well as spur competition and productivity.

The 2022 budget and accompanying reform programme included increased expenditures to boost productivity and narrow socioeconomic gaps. Compared to the pre-pandemic 2019 budget, the 2022 budget targeted a decline in expenditure on defence as a share of GDP, and a marked increase for infrastructure investment, although implementation has fallen behind the plan. The accompanying reform programme included inter alia further medium- to long-term measures to boost infrastructure investment (around NIS 150 billion, 9% of GDP) and investment in Israeli-Arab communities (NIS 30 billion, 1.8% of GDP, over 2022-26). Investment in these areas is welcome, given Israel’s large infrastructure gap (Figure 1.9) and wide socioeconomic divides. Additional investment is also needed to boost human capital as argued in Chapter 2 and previous Surveys. Investment in these areas should be based on sound cost-benefit analysis. With extraordinary tax revenues waning, stabilising public debt while making these investments requires additional efforts to enhance spending efficiency, and to increase tax revenues. The new government’s economic reform plan includes a national infrastructure law with the aim to facilitate the implementation of infrastructure projects by streamlining bureaucratic and regulatory processes. In addition, the reform plan foresees further measures to boost competition in a number of sectors, including the food sector, by reducing regulatory burdens and removing import barriers.

Figure 1.9. Israel’s core infrastructure stock lags significantly behind that of other countries’

Total core infrastructure stock, % of GDP, 2015

Reforms to boost labour force participation and productivity can help ensure long-run debt sustainability. In a baseline scenario, that assumes some continuation of pre-crisis trends of labour market integration, especially of Haredim and Arab-Israelis, debt will continue to fall to around 55% of GDP by 2030. Thereafter, gradually increasing ageing-related costs (pension, health) would lead to rising debt, unless offset through savings in other spending areas or higher revenues (Figure 1.10). A halt in the progress of labour market integration of Haredim and Arab-Israelis, whose combined share in the population increases to 50% by 2060, would have strong adverse effects on growth, tax revenues and raise social spending, and debt would increase earlier and much more strongly (Figure 1.10, Adverse scenario). In contrast, implementing a reform programme as suggested in this Survey (Box 1.1) would boost growth, speed up labour market integration and help stabilise debt below 60% of GDP until 2055 (Figure 1.10, Reform scenario).

Figure 1.10. Illustrative debt scenarios

General government debt, as a percentage of GDP

Fiscal policy has been prudent overall over the last two decades, but the fiscal framework would benefit from a regular review of the fiscal rules to enhance their credibility as fiscal anchors. The fiscal framework includes multiannual expenditure ceilings and deficit targets, and since 2017 a rule that restricts any new permanent fiscal commitments that would breach the expenditure and deficit rules without an appropriate funding source (“numerator rule”). The rules have helped contain spending, reduce debt and enhance fiscal planning. However, experience with the rules has also highlighted some shortcomings. The expenditure rule has in general implied a medium-term reduction in the public expenditure-to-GDP ratio. This has proven useful to enforce fiscal prudence in the 2000s when the expenditure and public debt-to-GDP ratios were significantly above the OECD average. The decline in public expenditure since 2008 was largely driven by lower spending on defence and interest payments, while other expenditures including public investment and social services remained broadly stable as a share of GDP following their reduction between 2003 and 2008. However, compliance with the rule has been more difficult in the last decade as primary civilian spending is low (see below) and infrastructure and human capital investment needs are large. The expenditure ceilings (and deficit targets) have often been revised up by changing the parameters of the rule ad hoc when budgets are prepared (Brender, 2021[5]) (BOI, 2022[4]). Moreover, the upward revisions of the ceiling tend to favour current over investment expenditures, as investment pipelines take time to prepare and are based on (more restrictive) medium-term fiscal plans (BOI, 2022[4]).

In addition, the deficit target has not prevented pro-cyclical fiscal policy, in particular during cyclical upswings (Brender, 2021[5]) (Rawdanowicz et al., 2021[6]). As deficit targets are not adjusted for the economic cycle, they have not limited the government’s ability to pro-cyclically cut taxes in upswings. In general, more buffers could be built during fiscal upswings. A regular review of the fiscal rules should take into account the trade-offs between simplicity, credibility and flexibility of the rules. It would also be an opportunity to assess prudent public debt levels, accounting for country-specific factors such as geopolitical risks. A regular review of the expenditure rule should be informed by a strategic long-term public investment plan, which is currently lacking, that takes into account investment needs for example for infrastructure and climate change adaptation and mitigation.

Looking forward, establishing an independent fiscal council, as recommended in the previous Survey, can strengthen the fiscal framework. Research shows that fiscal councils have been associated with increased fiscal rule compliance, more accurate forecasts, and less pro-cyclical fiscal policy (Rawdanowicz et al., 2021[6]).Three out of four OECD countries now have fiscal councils. Their mandates vary, but most commonly include monitoring compliance with fiscal rules, assessing long-term fiscal sustainability, analysing budgets and medium-term fiscal plans, endorsing or producing economic and fiscal forecasts, and estimating costings of policies. During the pandemic some councils have also assessed the conditions for triggering the escape clause. In Israel, the Bank of Israel provides independent macro-fiscal projections, budget analysis and fiscal advice to the government, and the State Comptroller conducts ex-post assessments of fiscal policies. Fiscal transparency and oversight could be strengthened for example by producing systematic long-term (more than 20 years) fiscal sustainability analysis, given the increasing importance of ageing-related pressures. Moreover, if the review of the fiscal rules were to result in the adoption of more complex rules, e.g. cyclically-adjusted or structural fiscal targets, formulating an agreed methodology and monitoring ex-ante and ex-post compliance would benefit from independent advice. In principle, the mandate of the central bank could be expanded in these directions. However, with an expanded fiscal advisory role, the central bank may face capacity constraints and possible conflicts of interest. Hence an independent fiscal council would be preferable.

The fiscal council should be aligned with international best practices such as the OECD Principles for Independent Fiscal Institutions (IFIs) (OECD, 2014[7]). Establishing a new independent institution is challenging. In this respect the OECD Principles for example recommend that the IFIs leadership’s term should optimally be independent of the electoral cycle, for example by defining the term span beyond the electoral cycle; IFIs should be precluded from any normative policy-making responsibilities; and the leadership should be elected strictly on the basis of merit and technical competence. If local recruitment proves difficult, some of the fiscal experts could potentially come from outside of Israel. IFIs in several OECD countries have links to the central bank to offer greater protection from potential political interference, while operating under strict independence and autonomy from the central bank. For example, in Austria, Estonia and the Slovak Republic the IFIs are funded by the central bank. In Austria and Estonia the central bank also provides the secretariat of the IFI. Mandates of IFIs evolve in OECD countries. In Israel the establishment of a fiscal council could be combined with an evaluation of its mandate after several years.

Tax reform to enhance equity and efficiency

Israel’s tax mix is reasonably growth- and employment friendly, as discussed in detail in the previous Survey. The tax burden on labour is relatively low in international comparison especially for low- and middle-income households. Taxes on consumption (mainly through VAT), which are generally less distortive, are used more heavily than in other OECD countries as are property taxes (Figure 1.11). However, the property tax in Israel suffers from several deficiencies which create distortions. In addition, there is scope to remove inefficient tax exemptions and to broaden tax bases. This could also help generate some additional tax revenues to finance investment needs. The overall tax burden, at 30.2% of GDP in 2019, is below the OECD average (33.4%).

In-work benefits should be permanently increased to strengthen work incentives and reduce the share of working poor. The personal income tax rate schedule is progressive (OECD, 2020[1]). In addition, a basic tax credit as well as a number of specific (non-refundable) tax credits, for example for families with children, single parents and working women, further contribute to the progressivity of the income tax system. Employment of workers with traditionally low labour market attachment has increased, but the jobs are often low-paid, especially among the Israeli-Arabs and Haredim. Israel’s Earned Income Tax Credit (EITC) is an effective redistribution measure with significantly positive employment effects for low-skilled workers (Brender and Strawczynski, 2020[9]). As discussed in detail in Chapter 2, the EITC should be adjusted to restore gender balance and strengthen incentives for second earners. In addition, further efforts should be made to reduce the delay in payment and automatically pay-out the EITC to eligible persons (Chapter 2).

Box 1.1. Quantifying the impact of selected policy recommendations

Table 1.3 presents estimates of the fiscal impact of selected recommendations. The results are indicative and do not allow for behavioural responses.

	% of GDP
Improving quality of education and expanding pre-school education in underserved areas	-0.6%
Strengthening active labour market policies and in-work benefits	-0.4%
Enhancing infrastructure	-0.6%
Total costs	-1.6%
Increasing statutory retirement age of women to that of men	+0.1%
Reducing inefficient tax expenditures and streamlining VAT exemptions	+0.8%
Environmental taxation (phase-out fossil fuel subsidies, broader carbon taxation)	+0.5%
Total savings and extra revenues	+1.4%
Revenue gain from the recommended reform package via higher employment¹⁾	+0.75%

¹⁾ The employment rate increases by around 1.5 percentage points by 2032 relative to baseline.

Source: OECD; Ministry of Finance, (IMF, 2022[8]).

Table 1.4 quantifies the GDP impact of the main recommendations based on the OECD Economics Department long-term model.

Reform	10 year effect	Effect by 2060
Labour and educational reforms: i) expanding pre-school funding per child; ii) improving quality of lagging school streams; iii) expanding active labour market policies; iv) increasing retirement age of women to align it with that of men; v) reducing inequality	2.2%	12.6%
Public infrastructure investment	1.1%	3.9%
Competition reforms i) reducing tariffs, ii) product market reforms	2.1%	8.9%
Total impact	5.4%	27.5%

Note: The total impact of reforms is not equal to the sum of the separate reforms because of interactions between reforms.

Source: OECD Economics Department Long-Term Model.

Figure 1.11. The tax mix relies more heavily on consumption and property

Share in total tax revenues, % of total taxation, 2020

Reducing inefficient tax expenditures can lower distortions. Differences in tax rates across saving vehicles are large and distort saving decisions. For example, tax benefits for private pension savings, medium-term savings accounts and residence-based income tax credits are inefficient and should be reduced (OECD, 2020[1]). Reducing these benefits should take into account the overall progressivity of the income tax schedule and effects on work decisions of higher-income earners, who are the main beneficiaries of these tax exemptions. The government should also strive to eliminate VAT exemptions, which are inefficient measures to address equity issues, create distortions and provide opportunities for tax evasion by re-classifying goods to benefit from exemptions. This includes the VAT exemption threshold on online purchases, and exemptions on tourism services (including in Eilat) and on fruits and vegetables. To offset potentially regressive effects, existing social transfers could be increased.

The taxation of housing should be reformed to remove distortions and foster fairness. The recurrent immovable property tax (Arnona) is based on the size of the property (together with other parameters such as location and type of housing). Most other OECD countries base the recurrent immovable property tax on the value of the property, although values are often not regularly updated to current market values (OECD, 2022[10]) (Thomas, 2021[11]). Digitalisation is reducing the costs of regular appraisals. Computer-assisted mass appraisals (CAMA), which estimate values for a group of properties using mathematical modelling, or using data from digital platforms advertising properties for sale may reduce the costs associated with frequent property revaluations (OECD, 2022[10]). As these approaches require technical capacities, they may be best undertaken by higher levels of government. Moreover, rates in Israel are typically significantly higher for commercial than residential property, which creates incentives for municipalities to favour business over residential property developments, contributing to the housing supply shortage. As recommended in the previous Survey, the government should move to a value-based system, ensuring regularly updated property values, and reduce the large disparity between residential and non-residential Arnona tax rates, for example by lowering the non-residential property tax rates and raising residential rates. Such a reform should be designed following a review of potential distributional implications across households and municipalities.

In addition, the authorities should consider reforming the taxation of rental income. Currently there are three methods for taxing rental income, which raises complexity and provides opportunities for tax arbitrage and abuse (Thomas, 2021[11]). Moving to a single system of taxation, as in most OECD countries, whereby net rental income (gross rental income minus allowable deductions) is taxed at marginal passive income tax rates, and requiring all income and expenses to be declared, can raise compliance, fairness and tax revenues. In return, the purchase taxes on residential property should be phased out for both single and multiple homes. Transaction taxes tend to hamper residential mobility, although this effect is mitigated in Israel as transaction taxes on first homes are only levied above a relatively high threshold of the property value. For example, in 2017 about 65% of first-time home buyers were tax exempt.

The government should thoroughly evaluate the system of corporate income tax breaks for export-oriented and high-tech firms, as recommended in the previous Survey. Eligible firms benefit from sharply reduced corporate income tax rates (effectively in the range of 5-16%, compared to a statutory rate of 23%). The schemes may have helped attract FDI. However, the fiscal costs are significant (0.4% of GDP per year) and comprehensive evaluations of its benefits are lacking. In addition, the schemes may distort the optimal allocation of factors of production across sectors and make it more difficult for domestic-oriented sectors to attract investment and skills (OECD, 2020[1]) (BOI, 2019[12]). A review should evaluate the social benefits and costs comprehensively. For example, on the benefit side, positive effects on investment should be corrected for investment that would have occurred without the incentive. Positive productivity effects on other firms through knowledge or technology spillovers should also be taken into account. On the social cost side, the evaluation should include net tax revenue losses, administrative and compliance burdens, and costs related to distortions in resource allocations. A review is also warranted in light of future changes in the international tax environment, such as the global minimum corporate income tax. Broadening the tax base could create room for further cuts in the statutory corporate income tax rate or a lighter business property tax, which would benefit the economy more broadly.

Environmentally-related taxes need to be better aligned with externalities. Environmentally-related tax revenues are relatively high compared to other OECD countries (Figure 1.11), mainly due to high excise taxes on gasoline and diesel and a high vehicle purchase tax. Indeed, the effective carbon tax rate in the transport sector is higher than the unweighted OECD average (EUR 316 vs 174 per tonne of CO₂in 2021). However, taxes on non-transport carbon-based fuels are very low and not aligned with environmental costs. For instance, the effective carbon tax in the electricity sector is around EUR 4 per tonne of CO₂ (compared to an unweighted OECD average of EUR 39 per tonne of CO₂in 2021) and around EUR 7 per tonne of CO₂in industry (compared to an unweighted OECD average of EUR 36 per tonne of CO₂in 2021), far below a midpoint estimate for carbon costs in 2020 of EUR 60 (see below). A government decision in 2021 aimed to increase the excise fuel tax outside of the transport sector, but the plan has not yet been approved by parliament. The planned introduction of congestion charges in the Tel-Aviv area as well as the phasing out of fossil fuel subsidies for diesel fuel in certain uses is welcome. Part of the extra revenues from higher environmental taxation should be used to avoid real income losses, in particular of low-income households, improve public transport and enhance energy efficiency measures. Although explicit revenue earmarking is generally to be discouraged as it creates rigidities in spending priorities, combining environmental taxation with redistribution towards vulnerable households and policies to provide green alternatives can help increase trust and acceptability.

Increasing spending efficiency

Primary civil spending is among the lowest in the OECD (Figure 1.12). Spending on defence and interest payments is internationally high but has declined in recent years. Spending reviews can help identify areas of potential efficiency gains. Israel conducts annual spending reviews. However, the scope of the spending reviews has been narrow (less than 5% of total government expenditure), focused on very specific programmes, and the results are generally not integrated into the budget process or medium-term fiscal framework. Broadening the scope of the reviews would help identify interactions between several expenditure programmes within a given policy area (e.g. welfare, defence). More comprehensive reviews can be more complex to carry out, possibly requiring more human resources, but the potential to identify efficiency gains is also larger. Fully harnessing the potential of digital technologies for government services can also bring efficiency gains.

Raising women’s retirement age will yield fiscal savings. At the beginning of 2022, women’s statutory retirement age started to gradually increase from 62 to 65 years. Annual savings are estimated to be modest, at around NIS 1.5 billion (0.1% of GDP) in the medium term (BOI, 2021[13]), given that the public system only finances a basic pension. In addition, the reform is welcome as it also strengthens incentives to stay in the labour force and boosts women’s pension income. The authorities should strive to fully close the retirement age gender gap by raising the retirement age of women further to that of men (67 years) in the medium term. Almost all OECD countries have eliminated or are in the process of eliminating the retirement age gender gap (OECD, 2021[14]). Once the retirement age of men and women are aligned, the government should consider linking the future retirement age to gains in life expectancy.

Figure 1.12. Primary civilian expenditure is low

Primary civilian expenditure, % of GDP, average 2019-2021

The new mechanism to guarantee yields of pension funds is likely to reduce government interest payments but creates contingent liabilities. In the past, the government issued earmarked bonds to pension funds with a fixed real yield of 4.86%. From 2022, these earmarked bonds will no longer be issued. Instead, the government will guarantee a real average annual yield of 5.15%, for the amount the pension funds traditionally invested in earmarked bonds (30% of portfolio). As long as yields in the capital market exceed the interest rate on government debt, which has historically been the case, this new mechanism will result in fiscal savings. However, in times of exceptional capital market downturns, the new mechanism may trigger substantial payments of the government to pension funds (BOI, 2021[13]). These new contingent liabilities should be made transparent and appropriate reserves established as planned.

Government transparency and low levels of corruption are key to boosting public-sector efficiency. Corruption can divert public resources from productive spending and is associated with lower spending on social services, including health and education (OECD, 2015[15]). In Israel, perceived levels of corruption are higher than the average for OECD countries (Figure 1.13). Moreover, judicial independence and judicial checks and balances are vital to a strong anti-corruption and public integrity system, trust in the government and public institutions and a business environment that attracts investment and fosters economic performance (OECD, 2022[16]) (Palumbo et al., 2013[17]), (European Commission, 2022[18]), (World Bank, 2017[19]), (IMF, 2017[20]).

Measures to mitigate risks of undue influence in policymaking can be strengthened to safeguard trust in public institutions and in a fair business environment. Israel has dedicated considerable efforts to improving accountability in public policy making in the areas of lobbying, conflict of interest, and political financing. However, access to public information should be enhanced, for instance by not restricting it to citizenship. Israel could also consider compliance with international standards such as the Tromso Convention, which establishes a set of minimum standards for the prompt and fair processing of requests for access to official documents. In addition, Israel should ensure that all ministers, members of parliament and highest bodies of the judiciary submit full declarations of possible conflicts of interest. Finally, the State Comptroller could improve the collection of data on the financing of political parties and election campaigns.

Further progress can also be made to strengthen the foreign bribery framework. Israel has fully implemented many recommendations of the OECD Working Group on Bribery related to the detection, investigation and prosecution of foreign bribery and to strengthen the role of its tax and anti-money laundering frameworks (OECD, 2017[21]). However, Israel has not yet implemented recommendations to amend its Penal Law in relation to crimes committed abroad. In particular, the law should be amended to make criminal jurisdiction and sanctions of the foreign bribery offences independent of the foreign country’s treatment of the offence (OECD, 2017[21]).

Figure 1.13. Perceived corruption is above the OECD average

Recommendations in past surveys	Actions taken since 2020
Establish an independent fiscal council.	No action taken
Make the temporary changes to the earned income tax credit permanent. Evaluate and consider expanding the programme further.	The 2019 changes of the EITC were phased out. As part of the cost of living support measures the EITC payout was temporarily increased in 2022.
Consider reducing tax breaks on savings in “advanced training funds”, taking into account effects on income distribution and work incentives. In the medium term, streamline VAT exemptions and offset any regressive effects with an increase in existing welfare programmes.	No action taken
Review the preferential tax treatment under the Law for the Encouragement of Capital Investment with a view to better targeting the scheme.	No action taken
Reduce the difference between non-residential and residential property tax rates. Replace the area-based property tax with a transparent and uniform system based on property values.	No action taken

Preparing the health care sector for future challenges

The COVID-19 pandemic demonstrated the strength of the health care sector but also exposed some challenges

The health impact of the crisis, as measured by excess mortality, was around the average across the OECD countries (Figure 1.14). Israel’s younger population, with only around 12% of the population aged 65 years and above compared to around 18% in the OECD, universal health insurance coverage and high-quality health care were factors limiting the health impact (Box 1.2). Moreover, the authorities allocated substantial additional resources to the health response, around NIS 30 billion (1.9% of GDP) from March 2020 to March 2022. Most importantly, Israel rolled out one of the fastest vaccination campaigns in the world (Figure 1.1, Box 1.3) and was one of the first countries to introduce a health pass (“Green Badge”) in early 2021, which allowed vaccinated, recovered or negatively tested people to access hospitality, cultural and leisure activities (BOI, 2022[4]). The vaccination campaign and the introduction of the health pass allowed the authorities to avoid general lockdowns during subsequent waves of the pandemic, limiting the economic damage. While a lower share of the total population is vaccinated than in many OECD countries (Figure 1.15), this is largely due to Israel’s significantly larger share of young people. Among the people aged 20 and above the vaccination rate (2 doses) reaches 85%.

Figure 1.14. The mortality impact of the pandemic has been similar to that in many OECD countries

Excess mortality 2020-2021, %

Figure 1.15. The vaccination campaign was very fast

People fully vaccinated against COVID-19, share of total population, %

The advanced state of telemedicine in Israel helped maintain medical services during the pandemic. The existing telemedicine infrastructure was able to absorb the decline in in-person visits (OECD, 2021[22]). A national digital health programme launched by the government in 2015 included various initiatives related to remote patient monitoring and remote service delivery. The four statutory health insurance funds offer tele-consultation services with many providers (OECD, 2019[23]). During the pandemic, tele-consultations accounted for one third of all doctor consultations in primary care. However, a lack of awareness of the services was one of the main reasons for the lower use of telemedicine among the Arab-Israeli population (Penn, Goldwag and Laron, 2021[24]).

However, the health impact of the pandemic differed notably across population groups, mirroring pre-existing socio-economic divides in health status. Data until September 2021 show that infection rates were 2.5 times higher in Haredi localities compared to non-Haredi localities, reflecting more crowded living conditions but also higher rates of non-compliance with COVID-19 restrictions. Severe cases of infections leading to hospitalisations were particularly prevalent in Arab localities (Weinreb, 2021[25]). Despite success with targeted campaigns to enhance trust and tackle misinformation (see Box 1.3), vaccination rates remained lower among poorer population groups, especially Israeli-Arabs and Haredim (Davidovitch, Levi and Arazi, 2021[26]). This was due to higher vaccine hesitancy among these groups and some difficulties in accessing vaccination sites especially in smaller and Bedouin villages (Rosen et al., 2021[27]). However, the worse COVID-outcomes among Israeli-Arabs also mirror generally weaker health outcomes, partly reflecting behavioural and cultural factors (Weinreb, 2021[25]). Israeli-Arab men smoke far more than the rest of the population and the lung cancer incidence is 50% higher among Arab Israeli men than Jewish men. In addition, obesity, diabetes and heart diseases are much more prevalent in the Arab than in the Jewish population (Weinreb and Seela, 2021[28]). Overall, the life expectancy of Israeli-Arab men declined by more than a year during the pandemic and is about five years lower than that of Jewish men (Figure 1.16). General mortality rates are significantly higher in Arab localities (Davidovitch, Levi and Arazi, 2021[26]). The pandemic has thus been a stark reminder of the importance of health promotion, education and prevention programmes to narrow socio-economic divides in health outcomes. In 2021 Israel introduced a tax on sugar-sweetened beverages, similar to several other OECD countries in the last decade. Such a tax can be a useful tool to lower the consumption of these beverages (OECD, 2019[29]), and thus lower the risk of diabetes and other chronic diseases related to overweight.

Box 1.2. Overview of the Israeli health care sector

The Ministry of Health is responsible for the governance of the health system overseeing the performance of hospitals, health insurance funds, and health care professionals. The Ministry is responsible for providing a broad range of public health services. Health care is regulated by the national health insurance (NHI) law, which ensures universal access to health services for all residents. Each resident is free to choose from among four competing non-profit health insurance funds. The health funds are financed by the government within the framework of the NHI. They are obligated to provide their members with a broad government-determined benefits package, which includes hospital care, community-based care, and various preventive services. Some of these services are provided directly by the health funds, while others are purchased by the health funds from other providers.

Source: (Rosen et al., 2021[27])

Figure 1.16. Overall health outcomes are strong but substantially weaker for Israeli-Arabs

The crisis exposed some capacity constraints in the health care sector. Health care capacity was relatively low in international comparison before the crisis. The number of acute care beds was relatively low, and very high occupancy rates have been a long-standing concern (Figure 1.17, (OECD, 2013[30])). In addition, 29% of survey respondents indicated in 2018 forgoing some medical care because of long waiting times (Brammli-Greenberg, Yaari and Avni, 2020[31]). Moreover, there is wide regional variation, with the number of beds particularly low in northern and southern districts. General intensive care beds constitute only 3% of all acute care hospital beds compared to about 5% in Europe and about 10% in the United States (State Comptroller, 2021[32]). Similarly, the number of doctors and nurses per population is below the OECD average (Figure 1.17). Israel’s relatively young population and emphasis on primary care provision (which is less staff-intensive than hospital care) suggest that optimal hospital bed and staffing levels may lie below those in other OECD countries. However, according to a special report by the State Comptroller (State Comptroller, 2021[32]), the hospital system suffered from a shortage in manpower and intensive and acute care beds during the COVID-19 pandemic. The private health care sector partly compensated for reduced elective surgeries in the public sector. In addition, the government supported the recruitment of 600 physicians, 2000 nurses and 700 auxiliary positions during the crisis, which were eventually made permanent. This is welcome but sustainably strengthening the resilience of the health care sector will require addressing structural challenges as discussed in the next sections.

Box 1.3. Drivers of Israel’s fast vaccination campaign

Israel started its vaccination campaign in December 2020. By April 2021 already about 70% of the adult population was fully vaccinated (two doses), several months before other countries achieved such a rate (BOI, 2022[4]). Israel was also one of the first country to offer its citizens a third vaccination from July 2021, and a fourth vaccination to senior citizens and high-risk groups in December 2021. Several factors contributed to the remarkable speed of the vaccination campaign (Waitzberg and Davidovitch, 2021[33]):

Early and sufficient procurement of vaccines: The government procured vaccines early from Pfizer/BioNTech in exchange for data to research the vaccine efficacy. Israel provided Pfizer/BioNTech weekly updates on the progress of its immunisation programme, sharing anonymised aggregate epidemiological data such as the number of confirmed COVID-19 cases, hospitalisations, ventilated patients, and deaths, as well as age and other demographic data (OECD, 2021[34]).

Highly digitised and health fund-based health care system: Nearly the entire Israeli population is included in one of the four electronic medical records (EHR) systems developed by the health funds (OECD, 2019[23]). The EHRs capture detailed patient-level information, including demographics, diagnostic and testing information, and drug utilisation data and support the sharing of information among physicians, laboratories, diagnostic centres, hospitals and patients (OECD, 2020[35]). This well-developed IT infrastructure allowed to provide research data quickly. The up-to-date and easily accessible health data by the health funds helped stratify vaccination efforts based on age and other risk factors and to actively contact clients and make vaccination appointments.

High-quality primary care network: Vaccinations were mainly rolled out via the primary care network including in remote areas. Nurses were authorized to vaccinate without physicians being present. As most outpatient nurses are employed by health funds, they could be rapidly deployed to the vaccination campaign.

Measures to enhance compliance: The Ministry of Health and the Israeli Medical Association launched awareness campaigns. The health funds together with civic society groups informally advertised daily the vaccination sites with remaining doses available for non-priority (young) people. Tailored out-reach for cultural minorities (Haredim and Israeli-Arabs), involving trusted community leaders, helped to enhance trust and tackle false information (OECD, 2021[36]).

Financial and non-financial incentives: The government financed the vaccination campaign and provided premia to health funds if they reached particular vaccination target rates among their client base. In addition, the health pass (“Green Badge”) policy, the imposition of costs of testing on those who chose not to get vaccinated and shorter isolation periods for vaccinated persons served to encourage vaccinations (BOI, 2022[4]).

Ensuring adequate numbers of health care workers

An ageing workforce and insufficient domestic training will aggravate labour shortages in the health care sector in the future. A large proportion of doctors are likely to retire in the coming years (Figure 1.18). In addition, the number of domestic medical graduates is very low despite a doubling of graduates in the last decade (Figure 1.18, Figure 1.19). As a result, Israel’s health care sector relies to a large extent on foreign-trained physicians. Nearly 60% of doctors in Israel in 2020 obtained their first medical degree outside the country, the highest rate in the OECD (OECD, 2021[22]). While this largely reflects strong immigration inflows in the 1990s, nearly half of all doctors who have obtained their first medical degree abroad were born in Israel. The large number of Israeli students studying abroad may reduce education costs for the country, but it raises at least two concerns: i) it complicates long-term planning of how many doctors will enter the medical profession; ii) it exposes the health sector to heterogeneity in the quality of medical education abroad.

Figure 1.17. Health care resources are lower than in most OECD countries

Figure 1.18. Many physicians head for retirement and too few new physicians are trained

A recent reform to ensure the quality of the medical education received abroad, will aggravate shortages of physicians especially in the northern and southern districts (periphery henceforth). In 2018, the Ministry of Health tightened the criteria for obtaining a medical license and shortened the list of foreign medical faculties that are recognized in Israel (“Yatziv reform”). As a result, most medical schools in countries including Moldova, Armenia, Georgia and Romania were disqualified. These schools had accounted for about one-third of all new doctors in 2021 (Figure 1.19). From 2026, students from these schools will not be able to participate in licencing exams. The reform will therefore accelerate the future decline of the number of doctors per capita (Figure 1.19). In addition, it will hit particularly hard hospitals in the periphery. About 60% of newly-trained doctors in the northern and southern district are from foreign schools that will be disqualified, aggravating the physician shortage in these districts (Figure 1.17).

Several complementary strategies are needed to increase the supply of doctors in the future. First and foremost, the number of Israeli students admitted in medical schools in Israel needs to increase further as quickly as possible. This can be achieved by increasing the student intakes in existing medical schools. Moreover, foreign medical students who do not commit to practice in Israel after their studies should be charged tuition fees that reflect the costs of their education. Second, given the capacity constraints in Israeli medical schools, financial support (in the form of loans and grants) can be provided to Israeli students to obtain their first medical degree in accredited schools abroad as the government plans (Ofakim programme) and as is done in Norway for example. Third, to increase the number of internship and residency training posts of both domestically-trained and foreign-trained students to complete their training in Israel, the range of settings where postgraduate training can occur (e.g. in primary care settings and to a lesser extent private facilities) should be expanded.

Incentives for newly-trained doctors can be strengthened to reduce the shortage of physicians in the periphery. A grant programme to incentivise doctors to settle in these districts was cancelled as evaluations showed that the programme subsidised many people who would have moved to the periphery in any case. More recently, the authorities initiated a programme (Ilanot programme) to subsidise tuition at medical schools in the periphery for qualified students from the periphery, based on OECD research (Ono, Schoenstein and Buchan, 2014[37]) that these students are most likely to stay in the periphery after their studies. In addition, any new financial support programme for students going to study in accredited schools abroad could make it more advantageous for students to pursue their postgraduate training and work in the periphery, for example by transforming part of their loan into a non-reimbursable bursary. Alternatively, work requirements for subsidised foreign trained students could be differentiated according to the place of work. For example, the Becas Chile programme, which provides scholarships for Chileans to obtain PhDs abroad, cuts the required number of years that scholars need to return to Chile in half for those who live and work in the periphery.

Israel should consider reforming the governance of health workforce planning. The Ministry of Health (Administration for Strategic and Economic Planning) in cooperation with the Central Bureau of Statistics have recently improved their capabilities to project the future supply and demand of physicians. In contrast to many other OECD countries, in Israel medical licences are given for life without the need for renewal. This complicates the planning process as no data is available on whether licensed doctors are still active. Therefore, more significant steps to improve the planning capacity are needed. For example, an independent body like the Advisory Council on Medical Manpower Planning (ACMMP) in the Netherlands could be established to gather all the main stakeholders. The ACMMP is composed of three groups of stakeholders (medical associations, training institutions and health insurance companies) with each group having equal weight in the overall management and decision-making processes. Such an institution could be tasked with providing regular and independent assessments about workforce projections and advising on student intake to fill the projected needs, reflecting the views of the main stakeholders.

Figure 1.19. The supply of physicians has increased but is insufficient to keep up with population growth and ageing

In the short term, the potential to shift tasks between professions, for instance from doctors to nurses, should be further exploited. In recent years, there has been significant progress in this direction with the development of the role of advanced practice nurse - a nurse with special training who is permitted, under certain restrictions, to diagnose illnesses, write prescriptions, and carry out certain medical procedures. In addition physician assistants, who are certified to practice medicine under the supervision of a physician, are becoming increasingly common in Israel, primarily in emergency medicine. The further development of these new positions has the potential to alleviate shortages in the healthcare workforce, particularly in the periphery (Davidovitch, Levi and Arazi, 2021[26]).

Ensuring equal access and efficiency in the health care sector

Israel achieves its overall good health outcomes with relatively limited financial resources. Total health care spending in percent of GDP is lower than on average in the OECD and remained relative stable in the past two decades in contrast to the strong increase in most other OECD countries (Figure 1.20). Even adjusting for Israel’s younger population, recent OECD research suggests that per capita health spending is still about 15-20% below the OECD average (OECD, 2021[38]). The low spending is partly explained by the focus on the efficient delivery of primary care, including through larger health clinics and the organisation of doctors working in the community into teams, which allows them to deliver follow-up support, preventive activities and regular monitoring (OECD, 2016[39]). Health spending is projected to increase according to OECD estimates due to population ageing, cost pressures from new technologies, income effects and assumed lower productivity of the health care sector compared to the rest of the economy (Baumol effect). Nevertheless, spending is projected to remain below the OECD average in 2040 (Figure 1.20).

Figure 1.20. Total health expenditure is low

The low share of public spending in total health care spending raises equity concerns. The share of public expenditure which finances the universal health care basket has fallen sharply from 1995 to 2005 after a major reform of the health care sector. The share has since then slightly increased again, but remains well below the OECD average (Figure 1.21). Households’ out-of-pocket expenditures have fallen since the mid-1990s and are now close to the OECD average. Co-payments are generally low and exemptions and discounts, including for chronically ill patients and elderly, exist. In contrast, the voluntary health insurance (VHI) market has expanded strongly. VHI is provided by both the health funds and private insurance companies and covers services not (e.g. adult dental care) or partially (e.g. physiotherapy) included in the universal health care basket. VHI also offers enhanced choice of providers or faster access to care in the private health care sector. Over 80% of the population is covered by VHIs. Nevertheless, VHI coverage is lower among low-income groups (Chernichovsky, 2019[40]). Moreover, survey evidence suggests that 10% of people forwent medical treatment due to costs in 2018, reaching 20% in the lowest income quintile (Brammli-Greenberg, Yaari and Avni, 2020[31]).

The universal health-care basket (NHI) should remain at the core of the system, requiring adequate public funding. Funding for the NHI basket needs to strike a balance between maintaining a sufficiently broad and updated basket to ensure affordable and equal access to high-quality health care while keeping costs of the health care sector in check. Frequent deficits of the health funds and hospitals in the past suggest that the budget envelope of the NHI has not always been sufficient to cover costs, although it also reflects a desire to stimulate efficiency gains. It is therefore welcome that the demographic component in the NHI funding formula has been recently adjusted to better account for population ageing. The approach to update the treatments and technologies included in the NHI basket is formal and transparent, based on recommendations of a committee comprising all relevant stakeholders. Yet, stronger weight could be given to the addition of preventive technologies compared to therapeutic technologies (Angel, Niv-Yagoda and Gamzu, 2021[41]).

Figure 1.21. Public health expenditure is low and voluntary private insurance widespread

Containing wage pressures in the health care sector would create room for an expansion of the volume of care. Reflecting price developments in the NHI funding formula has often been contentious. Prices of health care goods and services are about a third higher than on average in the OECD (OECD, 2021[22]), driven by strong wage increases of health care workers and internationally high wages especially for specialist physicians and nurses (Figure 1.22). This reflects labour shortages and fierce competition for health care workers between the four health funds, and between the public and private healthcare sectors (Angel, Niv-Yagoda and Gamzu, 2021[41]). Containing wage pressures will therefore first and foremost require boosting the supply of health care workers as discussed above. In addition, a wide variety of contract types between physicians and the health funds exists, hampering oversight of wage developments. Encouraging voluntary standardisation of physicians’ contracts with health funds, according to specialty and geographic region, could improve transparency and help to reduce wage pressures (Angel, Niv-Yagoda and Gamzu, 2021[41]).

Figure 1.22. Health sector wages are high and increasing fast

Improving reimbursement systems in the health care sector

The payment mechanism of the health funds should be regularly updated and further refined to limit harmful forms of competition. The universal health insurance (NHI) budget is allocated to the four health funds mainly based on prospective payments according to a capitation formula. The capitation formula was last updated in 2010 and takes only into account age, gender, residence (periphery vs. centre) and a few chronic conditions of the client base. The health funds are by law required to accept every client. However, if payments to the health funds do not adequately reflect projected costs, the funds have an incentive for back-door cream skimming activities and service distortion. For instance, there is some evidence that health funds engage in greater marketing efforts to attract more profitable young clients and offer less services in regions with worse health outcomes (Brammli-Greenberg, Glazer and Shmueli, 2018[42]). To reduce these incentives the capitation formula could be refined to include socio-economic variables and variables reflecting high-cost genetic conditions. Alternatively, compensations for patients with exceptionally high expenditures could be guaranteed retrospectively to enhance risk-sharing between the government and the funds (Brammli-Greenberg, Glazer and Waitzberg, 2019[43]). However, such risk-sharing should be moderate so as not to increase moral hazard. Greater use could also be made of retrospective pay-for-performance payments for prevention efforts, e.g. for reducing diabetes or high blood pressure.

Further improvements can be made to the reimbursement system of hospitals to strengthen price signals. Hospitals are mainly reimbursed based on a mixture of per diem mechanisms and diagnosis-related group (DRG) funding (more precisely Israel uses procedure-related groups (PRG)). The importance of DRG payments has increased over time, accounting for about a third of hospital revenues in 2019. However, a number of factors question the cost-reflectiveness of DRGs, limiting their effectiveness as steering tools for the provision of hospital care and contributing to over-provision or under-provision of certain procedures (Waitzberg et al., 2020[44]). First, DRGs are not frequently updated, and they do not reflect the complexity of cases and hence do not properly reflect the actual costs of each service. Second, health funds can negotiate discounts to DRGs with hospitals and are entitled to automatic discounts if caps to hospital reimbursements are reached. Third, hospitals in deficit have frequently received retrospective subsidies. A recent reform aims to eliminate the practice of retroactively subsidising hospitals in deficit and instead to allocate a monthly fixed budget to hospitals based on transparent criteria (e.g. size, location).

Reforming the governance of government-owned hospitals could help strengthen incentives to provide care efficiently. The Ministry of Health owns and manages 11 out of the 27 general hospitals, accounting for about half of the acute-care hospital beds. Government ownership of hospitals has potential benefits such as greater commitment of these hospitals to national objectives. However, there have been long-standing concerns that the governance structure leads to an inherent potential conflict of interest, as the Ministry of Health is both the main regulator of the health care system as well as a major provider. For example, there may be a reluctance to update DRGs for procedures that are profitable for government-owned hospitals, and government hospitals have benefitted more strongly from retrospective subsidies to cover their losses. Several committees over the years have recommended to shift the management of the government-owned hospitals to a separate entity (State Comptroller, 2020[45]). However, progress has proven difficult. In 2016, the management of the hospitals was shifted to a separate entity within the Ministry of Health in an effort to create a better separation between the regulatory and management functions within the Ministry. However, so far this has not alleviated the concerns (State Comptroller, 2020[45]).

Improvements in the reimbursement system of the health care system crucially depend on further efforts to collect, process and disseminate cost and quality data. For example, a database to evaluate the different patient-level parameters influencing healthcare spending could be developed to continuously improve the capitation formula (Angel, Niv-Yagoda and Gamzu, 2021[41]). Insufficient hospital cost data has also been an important barrier to further refine, update and reflect the complexity of cases in the DRG systems. The gradual implementation of a new automated costing system (Tesher) across hospitals is a step in the right direction. Gaps in quality of care data also hamper the evaluation of payment system reforms. For example, a reliable and relevant database on waiting times in the health system does not exist (Barnea, Niv-Yagoda and Weiss, 2021[46]). In the Netherlands among other OECD countries, the government introduced the mandatory publication of hospital waiting times. Steps in this direction are planned and median waiting times for five speciality care services in primary care are published.

Mitigating tensions between the public and private health care sectors

Interactions between the public and private health care system have created tensions and inefficiencies. Prices for privately-provided health care services are generally higher and costs are lower, as private providers can cream-skim profitable procedures on low-complexity patients and receive indirect subsidies from the public sector (e.g. training of medical personnel, emergency facilities). This competitive advantage of the private sector leads to a migration of scarce human resources to the private system, partly in the form of doctors with dual practice allocating more time to their private practice. This has created a vicious cycle of wage pressures, underutilized infrastructure (e.g. operating rooms) and longer waiting times in the public system (Chernichovsky, 2019[40]), leading in turn to stronger demand for services in the private sector financed by voluntary health insurance. The authorities have taken some steps to mitigate this problem, including by restricting the possibility for doctors to refer patients from the public sector to their own private practices. In addition, physicians who have benefitted from subsidised medical training could be required to spend a certain amount of time in the public sector.

There is scope to further enhance regulation of the commercial health insurance market. To level the playing field between the public and the private sector, regulation could set maximum prices in the private sector for medical services also provided by the public sector. In addition, the authorities could consider charging a fee on the private health care sector that reimburses the public sector for certain functions it performs for the private sector (e.g. emergency facilities, training).

Efforts to increase transparency and financial literacy in the insurance market should continue. Around 80% of households have the health funds’ VHI and 44% have commercial insurance. Many households have both types of insurance, leading to overlapping and redundant insurance coverage and inefficiencies (State Comptroller, 2020[47]). This is also suggested by the fact that commercial insurance providers have significantly lower loss ratios compared to the health funds’ VHI and insurances in other sectors, with the exception of group health insurances. This underscores the importance of continuing the authorities’ efforts to promote product standardisation and to increase product transparency, for example by mandating better and easier accessible information, and to raise financial awareness in the general population. A recent reform of the commercial health insurance that inter alia prohibits overlapping commercial insurance coverage in some cases and the recent development of digital tools for the insured to assess the extent of their coverage and detect double coverage are therefore welcome. In addition, a clear separation between the health funds VHI and commercial VHI policies should be further encouraged, so that these insurance policies offer complementary rather than duplicate coverage.

Accelerating the digital transformation to boost productivity

Speeding-up the digital transformation has the potential to boost productivity growth and reduce Israel’s productivity divide. OECD research has shown that the adoption and diffusion of digital technologies constitutes a key productivity lever (Gal et al., 2019[48]) (Sorbe et al., 2019[49]). In Israel, as in other OECD countries, the pandemic strongly accelerated the use of online technologies and services, such as telework, remote education and healthcare, and the use of e-government services (BOI, 2022[4]). While digitalisation can boost productivity, it also poses significant risks that existing socioeconomic gaps are aggravated if the uptake of digital technologies is uneven across firms and households.

The digital divide in Israel is large. The gap between internet use of people with low and high education is particularly high (Figure 1.23). This largely reflects differences in the use of the internet across population groups, with Israeli-Arabs and Haredim using home internet connections much less frequently (Figure 1.23). Haredi households often do not have internet access at home or smartphones for religious reasons. Similarly, the share of students having good access to remote learning (with a quiet place and a computer connected to the internet) is much lower among the Israeli-Arabs and Haredim (Bahar, 2020[50]). Analysis of teleworking patterns during the pandemic also revealed lower uptake among Israeli-Arabs and in peripheral districts even after controlling for factors such as industry of employment and education (BOI, 2022[4]). Removing barriers to telework for residence in peripheral districts, such as gaps in digital infrastructure and skills, has the potential to open up new job opportunities in the centre of the country, for example in the high-tech sector (Chapter 2).

Firms lag in the adoption of many digital tools and technologies. ICT investment is slightly higher than on average in the OECD but lags significantly behind top performing countries like Switzerland and Sweden (OECD, 2022[51]). ICT investment is also very concentrated, with ICT services sectors accounting for around a third of total ICT investment. More importantly, firms lag in the adoption of advanced digital tools and technologies compared to top performing countries (Figure 1.24). The gap is particularly pronounced outside of the high-tech sector, such as in traditional manufacturing industries and wholesale and retail trade, and food and accommodation services, as well as in smaller firms (Figure 1.24, (Be’ery and Esperanza, 2021[52])). The gap in digital technology adoption therefore mirrors the broader productivity divide in the economy. A recent national committee (Committee for Economic Advancement of the Commerce and Service Sectors, 2021) highlighted the importance of investing in technology adoption to boost productivity in traditional services sectors in Israel, together with fostering competition and skills.

Policymakers have different tools to boost digital adoption. This includes better availability of high-speed broadband, enhanced access to government services, boosting digital skills, complementary investments in intangible assets (e.g. R&D, organisation, management), and lowering regulatory barriers to competition to foster business dynamism (Pisu et al., 2021[53]). Recent research also highlights a lack of skills, access to funding and complementary investments as the main barriers to digital adoption by firms in Israel (Golstein-Galperin et al., 2022[54]). Analyses on the digital transformation hinges on the availability of timely and reliable data. Data collection on the adoption of digital tools by firms, conducted by the statistical office for the first and only time so far in 2020, should henceforth be carried out systematically.

Figure 1.23. The digital divide is large

Figure 1.24. Firms in traditional sectors lag in the adoption of digital technologies

Improving communication infrastructure and digital government services for all

Access to reliable and fast fixed and mobile broadband connections constitutes the backbone of a digital economy. Recent OECD research suggest that increasing access to high-speed broadband can yield large productivity gains (Sorbe et al., 2019[49]). While mobile broadband penetration is high in Israel, the share of households with a fixed broadband connection is lower than in other OECD countries and the difference between regions is large (Figure 1.25, (OECD, 2022[55])). Connections are particularly low in Jerusalem, which likely reflects the larger share of Haredi households in Jerusalem. However, connections are also low in the northern and southern districts, where many Israeli-Arabs live.

Figure 1.25. Broadband connections vary widely across regions

% of households with Internet broadband connections, 2020 or latest available year

Broadband connections are relatively slow for many households and businesses but the deployment of fibre is progressing and 5G deployment is underway. The share of firms with access to high-speed internet access (speeds greater than 100 Mbit/s) is low (Figure 1.26). This partly reflects a low share of fibre subscriptions in total broadband subscriptions. After a slow start, the deployment of ultra-fast broadband networks is now progressing quickly (Figure 1.26). According to the authorities, the share of fibre subscriptions further increased to 40% in 2022. The government adopted the “Fibre Roadmap” in 2020, and recently updated its aim to reach universal fibre coverage by 2026. Fibre networks can facilitate the deployment of 5G mobile networks, which offload mobile traffic into fixed networks. The deployment of 5G networks is underway, with three companies winning auctions in 2020. The government is planning supplementary spectrum auctions to increase bandwidth.

Figure 1.26. High-speed broadband connections lag behind peers

The authorities should closely monitor the deployment of ultra-fast broadband connections in underserved areas. The authorities estimate that connections to about 15% of households are not commercially viable, especially in Haredi, Arab and rural localities. To reach those households the government has established a fund into which telecom operators have to pay a 0.5% annual tax on their revenues. Through a tender process, operators can receive subsidies financed by this fund to deploy fibre networks in underserved areas. The first tender in early 2022 saw 10 companies win licences to deploy networks to about 10% of households, leaving around 5% of households unserved. If future tenders prove less successful, the subsidies received by the operators may need to be adjusted to reflect actual deployment costs.

Fostering competition in broadband deployment can also help reach underserved regions. Telecom markets are considered highly competitive in Israel and prices for mobile and fixed connections are low. However, OECD indicators suggest room to improve regulations to foster competition (see below). For instance, barriers to foreign entry into the telecom market remain high and certain domestic regulations, such as the prohibition of secondary spectrum trading, restrict competition.

Enhancing the provision and use of e-government services can improve government efficiency, increase transparency and foster the adoption of digital technologies by firms (Sorbe et al., 2019[49]). Israel scores well in the OECD Digital Government Index (Figure 1.27), which aims to assess the implementation of the OECD Recommendations on Digital Government Strategies. However, the index also points to some room for improvement to make the development of services more user-driven, through improving stakeholder engagement and better gathering and using data on user satisfaction with services. Israel has improved in the OECD OURdata Index 2019, which benchmarks the design and implementation of open data policies at the central level. However, it continues to lag in promoting the re-use of government data inside and outside of the government as well as in measuring the impact of open data policies.

Figure 1.27. The digitalisation of the government is advanced

OECD Digital Government Index, composite results, range from 0 to 1 (best practices), 2019

The pandemic has led to a surge in the use of digital government services. While the share of individuals using the internet to interact with public authorities was relatively low before the pandemic (OECD, 2022[55]), the use increased substantially during the crisis. The government website (gov.il) served as a central channel for government provision of information and services to the public on various COVID-19 related issues, including unemployment benefits, grants to the self-employed and to employers, and state-guaranteed loans. The number of people registered in the national identification system, which enables the use of government services with a high security level, increased from around 500 thousand in 2019 to over 2 million at the end of 2021 (BOI, 2022[4]). Efforts are ongoing to implement the “Once-Only-Principle”, according to which users, who have provided data to one government agency, should not have to provide the same data again for another agency. For these efforts to be successful, barriers for data sharing between public administrations need to be further reduced, for example through standardisation to increase interoperability between databases. As discussed elsewhere in the Survey, there is also significant potential to improve the efficiency of government services in the areas of labour market policies and health care by fostering data collection and dissemination.

Changes to the public pay system can help attract digital skills to the public sector. The public pay system is rigid in Israel and mainly rewards education and seniority instead of competences (OECD, 2021[56]). In addition, pay rises in one job classification often trigger pay rises in other job classifications. A more flexible approach to public wages would allow raising wages for occupations with recruitment problems such as IT specialists. In the United Kingdom, for instance, government departments can set higher wages for occupations with recruitment and retention problems while overall wage negotiations remain subject to departmental spending limits set out by the Treasury.

Fostering digital skills, competition, and intangible investment

The effective use of digital technologies relies on a comprehensive set of skills (Pisu et al., 2021[53]). Digital skills are also crucial to benefit from the opportunities of teleworking and to find and apply for jobs, as many positions are now primarily advertised online. As discussed in detail in previous Surveys (OECD, 2020[1]) (OECD, 2018[57]), there is a wide variation in skills, as some Israelis have outstanding skills, while a large number are comparatively low-skilled. In addition, problem-solving skills in technology-rich environments fall short of most OECD countries according to the Survey of Adult Skills (PIAAC) data (Figure 1.28). The gap is particularly pronounced for the younger generation, with only about 35% of the 25-35 year olds scoring high in these skills compared with an OECD average of almost 45%.

Building strong lifelong learning systems, including both high-quality initial education and adult learning, is critical to providing firms and workers with the right skills in a digitalised world. As discussed in detail in Chapter 2 and previous Surveys, enhancing skills in Israel requires first and foremost more investment in pre-school education, improving digital education in middle schools, building bridges between the various parts of the fragmented school system, improving teacher quality, strengthening work-based vocational education, and improving the responsiveness of the educational system to labour market needs.

Enrolment in ICT training should be encouraged. The share of firms providing ICT training is one of the lowest in the OECD (Figure 1.28). Many OECD countries encourage work-based training via subsidies or tax breaks for employers to provide training. In addition, as discussed in Chapter 2, incentives for individuals to take up training, especially targeted at those least likely to receive firm-based training, should be strengthened. For instance, personal account schemes allowing individuals to save up time for training purposes can help overcome time constraints, which are one of the barriers to employees wishing to engage in training. For example, France has been using such accounts, enabling employees to use training hours to acquire recognised qualifications or basic skills. It is important that the system be accompanied by strong guidance to steer training into relevant labour market fields and a robust quality assurance of training providers, and that the programmes should be regularly evaluated.

Figure 1.28. Average digital skills are weak and ICT training low

Lowering barriers that protect markets and promoting best-practice regulation are essential to spur the adoption of digital technologies, as competition encourages firms to invest and innovate (Sorbe et al., 2019[49]). Regulations in a number of areas are more restrictive than in other OECD countries (Figure 1.29). According to the OECD Product Market Regulation indicators, barriers to trade and investment and the government’s involvement in business operations, mainly due to still widespread price regulations and deficiencies in public procurement, remain high. For example, preferences are granted to local suppliers in procurement markets, particularly through the use of offsets. The authorities should also allot a period of time to submit a bid that is proportionate to the size and complexity of the tender. This is particularly important in technically complex projects where it may take time to develop more accurate cost estimates. More competition in public tenders would promote efficiency and lower prices. There is also at least one major state-owned enterprise in broadcasting, courier services, rail freight transport, and logistics cargo handling. Israel is also more closed to digital trade mainly due to barriers to interconnections among network operators as well as some restrictions on cross-border data flows (Figure 1.29, (OECD, 2021[58])).

Several major reforms have been enacted recently, in line with previous OECD recommendations, which have the potential to significantly improve the regulatory environment and boost foreign competition. A new regulatory oversight body is set to be established to strengthen ex-ante and ex-post regulatory impact assessments (RIA). All regulators are obliged to consult with the new body about their RIAs. In addition, the government approved a reform to streamline environmental permits into one licence, but the reform has yet to be approved by Parliament. “Silence-is-consent” rules are increasingly applied for business licencing. Most importantly, non-tariff import barriers will be significantly reduced. For a substantial number of goods – including consumer products and foods – domestic regulatory approval will be granted automatically if these products conform to international (US and EU) approved standards. As a result, many products will only require a self-declaration instead of costly and time-consuming lab verification and/or testing processes. Finally, the authorities have continued to reduce tariffs on most food and non-food products. However, tariffs and regulations remain distorting in the agricultural sector. Israel maintains high tariffs for goods such as poultry meat, sheep meat, and certain fruits and vegetables. These should be gradually removed and replaced temporarily by direct payments to farmers, if necessary. The tariff system for agriculture should also be simplified, avoiding non-ad-valorem tariffs (OECD, 2022[59]).

Figure 1.29. Product market regulations can be improved in several areas

The cost of regulations should be better measured. A recent committee (Committee for Economic Advancement of the Commerce and Service Sectors, 2021) recommended to measure the costs of regulations based on the Standard Cost Model (SCM) as is the practice in many OECD countries. This would help monitor performance in reducing administrative burdens and identify the most costly regulations. For instance, in Slovakia the government recently approved legislation for a “one-in, two out” principle, according to which the costs for businesses and citizens of any new regulation have to be quantified and regulations phased out that save businesses and citizens twice the amount.

Financial market imperfections can hinder investment in intangible assets (R&D, databases, software) especially for small and young firms, since intangible capital is more difficult to collateralise than physical capital. The development of venture capital markets and government support to R&D can help overcome these market failures and spur firms’ investment in intangible capital as well as boost digital adoption (Berlingieri et al., 2020[60]). Israel has one of the largest venture capital markets (relative to its size) in the world. In addition, the authorities actively promote R&D and innovation through favourable tax treatment of expenses and income from intellectual property, as well as direct support measures (e.g. R&D grants and procurement). While data on the value of income- and expenditure-based R&D tax incentives are lacking, direct government support is high, amounting to around 0.1% of GDP (Figure 1.30).

There is room to rebalance support for innovation. Direct government R&D support mainly benefits a few sectors, with high-tech sectors accounting for 80% of total government-funded business R&D (Figure 1.28). The government should continue expanding targeted grant programmes that support innovation and technology adoption in lagging sectors. As discussed in detail in the previous Survey, the government should also evaluate the current system of preferential tax rates for intellectual property (IP)-based income and consider replacing it with a broader system of tax credits for R&D expenditure. The benefits of IP boxes and similar income-based provisions are likely to accrue mainly to large MNEs, as they hold most intellectual property (Appelt et al., 2016[61]). Expenditure-based measures do not depend on the success of the investment and directly support the financing of R&D. Thus, they could help overcome difficulties in obtaining external funds, which is particularly important for small and young firms. To avoid overly favouring incumbents, tax benefits should include carry-forward provisions or cash refunds. Tax incentives could also go beyond R&D and target innovation activity more broadly, including, for example, training, ICT investment or IP acquisitions as eligible expenditure. For example, the French innovation tax credit includes patent fees as eligible expenditure for SMEs, which may help small firms adopt new technologies.

Figure 1.30. Direct government R&D support is significant but concentrated in a few sectors

Targeted support for technology adoption, which is largely focused on the manufacturing sector, should be expanded and broadened. Apart from R&D support, the authorities have more recently established several grant programmes for firms in traditional manufacturing industries (such as plastic, metals, textiles and food). In particular, the “Increasing Productivity in Industry” and the “Implementing Advanced Manufacturing Technologies” programmes, established in 2017 and 2018, respectively, support productivity-enhancing investment and the adoption of advanced manufacturing/industry 4.0 production technologies. Several programmes also target digital technology adoption in SMEs, such as subsidised training and consulting, and grants to promote e-commerce. Moreover, existing grants for digital technology adoption of SMEs in the manufacturing sector have been broadened to include traditional services sectors. However, these programmes are of small scale. Israel may consider the examples of other OECD countries to widen the range of policies to help SMEs digitalise (Box 1.4).

Box 1.4. OECD countries use a wide range of policies to help SMEs digitalise

OECD countries offer a wide spectrum of policies to help SMEs digitalise, ranging from grants that subsidise investments in digital technologies to training to help firms implement investments at their own cost.

Australia’s Small Business Digital Champions project supports small businesses. The project has a total budget of AUD 8.9 million, and provides up to AUD 18 500 (about EUR 13 000) in assistance, with additional support from partner firms. Of these small businesses, 15 were chosen as Digital Champions and received mentoring from high-profile business people to guide them through the digital transformation. This process is then documented and showcased online. The programme is complemented by the “Digital Solutions” programme of the Small Business Advisory Service, which focuses on firms in regional locations. SMEs pay a (subsidised) fee for advice on implementing digital technologies, such as websites, e-commerce, social media and small business software. The programme also offers advice on online security and data privacy.

In Denmark, the Danish Business Authority distributes grants (valued at approximately EUR 1 300) to 2 000 SMEs under the SMV:Digital programme. The grants are used for private consultancy to help the SMEs identify digital opportunities with a special focus on e-commerce, prepare business cases for digital transformation and implement digital solutions.

Portugal also has a grant scheme to assist SMEs with the use of digital technologies in fields such as e-commerce, online marketing, website development and big data. The grant covers 75% of eligible expenses up to EUR 7 500 for projects that take up to one year to implement.

Austria does not offer grants, but helps SMEs digitalise through the KMU Digital programme. The programme includes: 1) an online tool to allow firms to assess their level of digital maturity; 2) an individual consultation to examine what can be improved and how; 3) a consultation focused on the specific needs of the firm (in areas such as e-commerce, IT security, data protection and digitalisation of internal processes); and 4) digital skills training courses for entrepreneurs and employees.

Finally, Chile’s innovation agency recently launched the Digitalise Your SME (Digitaliza tu Pyme) programme which provides e-commerce courses (78 hours of classroom experience), in which small business owners can learn about digital marketing, the use of social networks and electronic commerce. By the end of the programme, participants learn processes associated with e-commerce such as the use of online platforms.

Source: OECD, Digital Economy Policy Platform (DEPP), edition 12/12/2021, https://depp.oecd.org/

Recommendations in past surveys	Actions taken since 2020
Further cut tariffs and non-tariff barriers, and streamline trade regulations	Tariffs on a number of food and non-food products have been further reduced. Domestic regulatory standards will be abolished for several consumer and foods products that conform to international (US and EU) approved standards.
Consider replacing the current system of preferential tax rates for IP-based income with a broader system of tax credits for R&D expenditure with cash refunds or carry-forward provisions.	No action taken.

Transitioning to carbon neutrality

The emission intensity of the economy has declined but air pollution remains a concern. Greenhouse gas (GhG) emissions have decoupled from GDP (Figure 1.31, Panel A) and have fallen by around 10% in per capita terms in the past decade (Figure 1.32, Panel A). The discovery of significant offshore gas fields has led to an ongoing transition out of coal and towards natural gas in electricity generation and improved energy security. Thanks to this transition, total GhG-emissions have stabilised in recent years despite strong economic and population growth (Figure 1.31, Panel B). However, emissions from transport, industrial processes and waste have continued to increase strongly. In addition, most Israelis are still exposed to heavy small-particle pollution, well above the WHO-recommended limit of 10 micrograms per m³(Figure 1.31). In 2020, transport was responsible for 34% of PM₁₀ emissions, while industry and waste burning accounted for 20% each.

Figure 1.31. Greenhouse gas emission intensity has fallen but air pollution remains a concern

The authorities have set more ambitious climate goals. In 2021, the government approved goals that seek to reduce net emissions by 27% by 2030 and 85% by 2050 from their 2015 level. Israel also declared its overall ambition of carbon neutrality by 2050. The previous targets, set in 2015, were defined in per capita terms and would have implied a further increase in total emissions. Achieving the more ambitious objectives requires to step up the pace of emission reductions compared to the past (Figure 1.32). Sectoral targets focus on further reductions in the electricity sector, and to a lesser extent in industry and waste, to reach the 2030 objective. To achieve this, the authorities are committed to end all coal-based electricity generation by 2026 and set the renewable energy target (predominantly solar) to 30% of total electricity generation, from currently only around 10%. A National Action Plan on Climate Change for 2022–26 defines more than a hundred measures to reduce emissions from electricity, transportation, industry, buildings and waste. However, the contribution of the measures to the reduction targets have not yet been quantified. The bill has not yet been approved by parliament, which would strengthen government accountability.

Figure 1.32. Reaching environmental targets requires accelerated policy action

The pricing of emissions needs to be better aligned with environmental costs and targets, and the coverage broadened. Israel does not have an explicit carbon tax but levies excise taxes on fuels at different rates depending on the type of fuel and its use. For instance, the effective carbon tax on gasoline is over EUR 300 per tonne of CO₂, while it is under EUR 2 per tonne of CO₂ for most uses of natural gas. Overall, only about 20% of carbon emissions from energy use are taxed at EUR 60 or above (Figure 1.33), which is a midpoint estimate for carbon costs in 2020, and a low-end estimate for 2030 (OECD, 2021[62]). Emissions priced at this level originated exclusively from the road transport sector. In contrast, only 1% of Israel’s electricity-related carbon emissions are priced above EUR 5, one of the lowest shares across OECD countries (OECD, 2020[63]). The large differences in tax rates across sectors and activities mean that marginal abatement costs are not equalised, increasing the cost of emission reductions. Furthermore, other air pollutants are not taxed.

A government decision in 2021 aimed to gradually increase fuel excise taxes but the plan has not yet been approved by parliament. The plan envisaged to raise all fuel excise taxes during 2023-28, except on gasoline and diesel for transportation, as these are already high internationally and in line with estimates of external costs in other countries for road use including GHG emissions, congestion, noise, accidents and local air (OECD, 2020[63]). The planned increases for coal and heavy fuel are relatively large, while the increases on natural gas are more modest. For instance, the excise tax on natural gas would only imply an effective carbon price of less than EUR 20 in 2028, significantly below the carbon costs and costs of other pollutants. In addition, these tax increases are unlikely to be high enough to reduce emissions to reach the government’s targets (IMF, 2022[8]). In the medium term, the authorities should strive to introduce measures to address carbon emissions unrelated to fuel combustion such as from industrial processes and waste, which have increased and account for around 20% of total GHG emissions. This could be via the expansion of the carbon pricing framework to these sectors or (second best) regulatory measures.

Decarbonising the electricity sector will require boosting renewable energy. The electricity sector is the largest GHG emitter, accounting for about 40% of total emissions. Israel has not invested in nuclear energy generation and there are currently no plans to do so. The planed phasing out of coal in electricity generation by 2026 will reduce GHG emissions as well as other air pollutants (e.g. SO_x and PM) with public health benefits. However, relying predominantly on natural gas will jeopardise the needed deep decarbonisation in the absence of widespread deployment of carbon capture and storage technologies. Higher fuel excise taxes on natural gas would make renewable energy production more competitive. Gas-fired power plants would have value as a backup to produce dispatchable electricity to offset the intermittency of renewables. Israel could also export more natural gas to countries where it could help reduce coal use. Gas exports to Jordan and Egypt commenced in 2020. An agreement to export to the European Union via LNG terminals in Egypt has recently been signed.

The expansion of renewable energy faces a number of barriers ( (OECD, 2020[1]), (OECD, 2020[63])). Israel has excellent solar resources but limited resources for other renewables. Utility-scale solar PV is already cheaper than natural gas, but its further deployment will require substantial investment to expand and upgrade grid and storage capacity, more public land available for tenders and streamlined permit procedures, for example by introducing legal time limits for permits. Distributed solar PV (e.g. on rooftops) overcomes land availability issues and the bottleneck of the transmission network, but still requires policy support as long as fossil fuel taxes are not aligned with external costs. Israel has developed innovative dual land use solutions such as covering water reservoirs and agricultural land with solar panels. The Ministry of Environmental Protection estimates that distributed solar installations could generate 40% of total electricity generation by 2030. Israel provides a range of policy support measures including tax exemptions, competitive tenders with long-term electricity purchase agreements for commercial installations and feed-in tariffs for residential installations. The Action Plan envisages mandatory rooftop solar PV installations on new buildings and support for technological innovations (e.g. storage, hydrogen, carbon capture). Further developing a competitive electricity wholesale market with high-resolution electricity pricing across time and space can help the power system adapt to intermittent renewables supply for example by strengthening incentives to invest in storage or smart appliances. Import of renewable energy from neighbouring countries could complement domestic generation. The recent declaration of intent with Jordan and the United Arab Emirates, under which Israel would provide Jordan with desalinated water in exchange for solar electricity, is a step in this direction.

Figure 1.33. Carbon taxation should be broadened

Major public transport projects are underway with the potential to reduce emissions from the transport sector in the long term. The transport sector is the second largest emitter of GHG, with emissions increasing due to population growth and the expansion of car ownership. Inadequate public transport infrastructure has been a long-standing concern. Several infrastructure projects have advanced in recent years including a train between Jerusalem and Tel Aviv and a light rail in Tel Aviv. A metro in the Tel Aviv Metropolitan area is planned to start operations in 2032. In order not to delay the construction of the metro, stable funding needs to be secured as the financing currently relies on new revenue sources, which will largely only materialise once the metro is in operation (BOI, 2021[13]). In addition, as recommended in the previous Survey, establishing metropolitan transport authorities can help improve coordination between the central and local government, and promote integrated transport and pricing solutions. In the shorter term, expanding and improving the quality of bus services as planned, can provide alternatives to car use. Further opening the bus market to competition in areas that are still controlled by the two dominant providers can reduce prices and improve quality (OECD, 2020[1]).

The taxation of private vehicle use can be further improved. The authorities plan to introduce congestion charges in the Tel Aviv metropolitan area in 2025. This is in line with previous OECD recommendations, although a kilometre-based charge proportional to the distance driven instead of the planned charges for entering three concentric rings would have had the advantage of leaving no trip unpriced (OECD, 2019[64]). Congestion charges should be accompanied by significant improvements in the quality of public transport services, higher municipal parking fees and the removal of income tax benefits for fringe benefits of car use (e.g. free parking provided by employers). Moreover, the government plans to phase out the reduced purchase tax rates for hybrid cars and tax them according to the standard methodology, i.e. a purchase tax rate of 83% minus a rebate that takes into account the environmental performance of the vehicle. The purchase tax on electric vehicles will increase from 10% to 35% by 2024. To increase the share of the electric vehicles in the car fleet, public and private investment into charging stations needs to be accelerated. With the shift to electric cars and the associated loss in revenues from fuel excise taxes, better reflecting external costs from car use, such as congestion, accidents, noise and infrastructure costs, becomes more pressing and could be addressed with distance-based charges (OECD/ITF, 2019[65]). Tax rebates for diesel used in buses, taxis, and trucks - costing about NIS 2 billion (0.1% of GDP) per year – have been reduced since 2018. This is welcome and the rebates should be fully phased out as planned.

Higher environmental taxes would have distributional consequences which should be addressed. Lower income households spend a larger share of total expenditure on energy in Israel (Stekel and Missbach, 2021[66]). Many OECD countries therefore recycle revenues of environmental taxes to address distributional concerns (D’Arcangelo et al., 2022[67]). Lump-sum transfers (as in Switzerland) are efficient and simple to administer but not well targeted and hence expensive. Targeted transfers to low-income households (as in British Columbia) are therefore preferable. Several countries have also used revenues to lower other taxes such as personal income taxes (e.g. Austria, British Columbia). In addition, revenues can be used to cushion the effects of higher energy costs by investing in energy efficiency measures, such as subsidies for retrofits (e.g. Switzerland) and green social housing (e.g. United States and Ireland), or public transport.

Energy-intensive firms (e.g. cement producers) can also be disproportionally affected, raising concerns of international competitiveness and carbon leakage. However, existing empirical evidence suggests limited effects of environmental fiscal reform on industry-level employment and competitiveness (OECD/IEA, 2021[68]). The issue of carbon leakage is best solved by global cooperation to ensure that the most emission-intensive and globally-traded sectors face a meaningful carbon price or equivalent regulations in major producer countries. In the absence of such global cooperation, domestic mechanisms can help level the playing field, but such mechanisms face challenges and trade-offs related to their practical implementation and effectiveness, costs, and WTO compliance. Any domestic compensations or rebates should maintain incentives to advance abatement efforts. In Switzerland, for example, firms exempted from the CO₂ levy on process fuels have to meet emission reduction goals. Firms exceeding the goal can receive abatement subsidies (Hintermann and Žarković, 2020[69]).

Recommendations in past surveys	Actions taken since 2020
Either introduce an economy-wide carbon tax or gradually increase the existing excise tax on primary fuels to levels that reflect estimated emissions externalities.	A government decision envisages a gradual increase in fuel excise taxes except on diesel and gasoline between 2023 and 2028.The detailed tax schedule has not yet been approved.
Introduce congestion charges, accompanied by significant improvements in the quality of public transport services and higher parking fees.	Congestion charges will be introduced in the Tel Aviv metropolitan area from 2025.
Use tenders integrating private and public land-use rights to attract investment into large-scale solar electricity generation and transmission networks, and make more public land available for tenders.	No action taken
Establish metropolitan transport authorities in the Tel Aviv area and other areas to promote integrated transport networks and pricing systems, and ensure stable financial support for public transport.	A government decision to establish metropolitan transport authorities is awaiting legislation. A new pricing system was launched in 2022, which includes significant discounts for monthly and yearly subscriptions, encouraging use of public transportation.

MAIN FINDINGS	RECOMMENDATIONS (key in bold)
Ensuring macroeconomic stability
The recovery is well advanced, but inflation has increased above the 1-3% central bank target. The budget has improved considerably in 2021-22. Risks to growth are elevated.	Maintain a tight monetary policy stance to bring inflation back to the target range. Maintain a neutral fiscal policy stance and ensure that fiscal support to vulnerable households and firms affected by higher costs is targeted and temporary
Exceptional revenues and the phasing out of pandemic support reduced debt, but spending needs remain large in several areas.	Formulate a medium-term fiscal strategy to ensure fiscal sustainability while encouraging adequate spending on infrastructure, education and labour market programmes.
Deficit and expenditure targets have frequently been revised, compromising their role as fiscal anchors, and fiscal policy has been pro-cyclical.	Regularly review the fiscal rules with a view to strengthen their effectiveness as credible fiscal anchors and reduce pro-cyclicality.
There is scope to reduce inefficient tax expenditures, which complicate the tax system and introduce distortions.	Reduce tax breaks on medium- to long-term saving vehicles and streamline VAT exemptions.
The municipal property tax system is opaque and provides incentives to favour commercial over residential real estate, contributing to housing shortages. Taxation of rental housing is complex and prone to tax evasion.	Reduce the difference between non-residential and residential property tax rates. Replace the area-based property tax with a system based on regularly updated property market values. Require all property rental income to be declared and taxed, and consider moving to a single system of rental taxation based on net rental income taxed at marginal passive income tax rates.
The business tax system provides large benefits to exporting and high-tech firms, which create distortions.	Review the preferential corporate income tax treatment of exporting and high-tech firms with a view to better target the scheme.
Women’s statutory retirement age will rise from 62 to 65 years in the coming decade but will remain below that of men (67).	Gradually increase the retirement age of women to that of men. Thereafter link the future statutory retirement age to changes in life expectancy.
Perceived levels of corruption are higher than on average in the OECD.	Continue efforts to fight corruption. Make criminal jurisdiction and sanctions of the foreign bribery offences independent of the foreign country’s treatment of the offence.
Sustaining good health outcomes in the future
The supply of physicians is insufficient to keep up with population growth and ageing, especially in the northern and southern districts. Physician shortages create cost pressures in the health care sector.	Increase the student intake in medical schools. Provide subsidies for selected students to obtain their first medical degree in accredited schools abroad in exchange for a commitment to practice in Israel for a minimum amount of time. Strengthen incentives for newly-trained doctors to work in the periphery. Establish a multi-stakeholder body to provide assessments about future supply and demand of doctors and recommendations about student intakes.
Reimbursement systems in the health care sector are not sufficiently cost-reflective, creating distortions, incentives for harmful competition and contributing to the waiting problem in the public health care sector.	Refine the capitation formula determining transfers to the health funds by adding socio-economic variables and variables reflecting genetic conditions. Regularly update diagnosis-related groups to ensure cost-reflectiveness and adjust them according to the complexity of cases. Further develop the collection, processing and dissemination of quality and cost information in the hospital sector. Consider establishing a separate authority to manage government-owned hospitals.
Interactions between the public and private health care system have created inefficiencies.	Regulate prices in private health care and establish a compensation mechanism for services provided by the public sector to the private health care sector.
Reducing the digital divide to foster productivity growth
Broadband connections vary widely across regions.	Closely monitor the deployment of fibre broadband connections in underserved areas and align subsidies with actual deployment costs if needed.
The economy is less open to foreign trade than most other small OECD countries	Further cut tariffs and non-tariff barriers, and streamline trade regulations.
IT skill shortages in the public sector create a barrier to the expansion of digital government services.	Introduce more flexibility to the public wage system by allowing higher wages for occupations with recruitment problems such as IT specialists.
R&D expenditure is concentrated in information industries. Benefits of IP boxes and similar income-based provisions are likely to accrue mainly to large MNEs, as they hold most intellectual property.	Consider replacing the current system of preferential tax rates for IP-based income with a broader system of tax credits for R&D expenditure with cash refunds or carry-forward provisions
The statistical office collected data on the digital adoption of firms the for the first and only time in 2020.	Systematically collect and disseminate data on the adoption of digital tools by firms.
Targeted firm support for technology adoption is of small scale and largely focused on the manufacturing sector.	Evaluate existing grants for technology adoption and digital training and expand effective programmes targeted towards SMEs in traditional sectors.
Accelerating the green transition
Only about a 20% of carbon emissions from energy use are taxed at EUR 60 or above, exclusively in the transport sector. Fuel excise taxes only cover about 80% of carbon emissions.	In the medium-term, gradually increase excise taxes on non-transport fuels to levels that reflect environmental costs and introduce consistent carbon pricing across all sectors. Partially use environmental tax revenues to mitigate distributional impacts, enhance energy efficiency and improve public transportation.
Despite vast solar potential, the share of renewable energy in electricity generation is one of the lowest in the OECD.	Streamline permit procedures and increase public land available for utility-scale solar installations while further strengthening incentives for distributed solar installations. Accelerate investment in the distribution network and storage capacity.
Electricity markets need to adapt to intermittent renewables supply.	Further develop the wholesale electricity market as planned, with high-resolution pricing across time and space, and competitive determination of market prices.
Public transportation is inadequate, and coordination between central government and local authorities in infrastructure projects is one of the least effective in the OECD.	Establish the metropolitan transport authority in the Tel Aviv area and in other areas to promote integrated transport networks and pricing systems. Ensure stable financial support for public transport.

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