The 2026 Budget in the Shadow of the Defense Burden and Future Priorities

This is an executive summary of a study published in Hebrew and presented at IDI's Eli Hurvitz Conference.

Photo by Sharon Leibel/Flash90

In this paper, we examine Israel’s 2026 state budget against the backdrop of the prolonged war that began on October 7, 2023, and the ongoing damage it has caused to Israel’s fiscal stability, growth prospects, and public services. The years of war have been marked by exceptional volatility in economic activity, repeated increases in defense spending, a rising public debt burden, and unusual uncertainty regarding the continuation or renewal of fighting on several fronts.

Our main conclusion is that the 2026 budget does not reflect the scale of the strategic fiscal adjustment now required. Israel cannot continue increasing defense spending, lowering taxes, financing reconstruction and rehabilitation needs, maintaining civilian services, investing in growth engines, and preserving fiscal stability all at once. Without a clear change in priorities, the continued rise in defense expenditure will lead to one of two outcomes: a sharp erosion of civilian spending, especially social services and infrastructure investment, or a further steep increase in the debt-to-GDP ratio. In practice, both outcomes would eventually harm the public, either through weaker services today or through a heavier debt burden in the future.

Background: A Changed Economic and Fiscal Reality

The 2026 budget was prepared after two and a half years of almost continuous war. During this period, Israel’s economy proved capable of recovering during periods of reduced military intensity, but the data show that the war has left significant scars. GDP remained below its pre-crisis trend, business-sector output was even further below trend, private consumption weakened, and investment fell sharply relative to its long-term path. The decline in investment is especially concerning, because it is likely to reduce the economy’s growth potential in the years ahead.

The budget was initially built on the assumption that 2026 would be the first year without renewed fighting. That assumption quickly proved too optimistic. Following the renewed confrontation with Iran and continued fighting on the northern front, the defense budget was increased substantially. At the same time, the growth and tax-revenue assumptions underlying the approved budget were not sufficiently conservative for a period of such exceptional uncertainty. Shortly after the budget’s approval, updated forecasts already pointed to lower expected growth and a higher deficit than the budget had assumed.

The fiscal implications are significant. The 2026 budget was approved with an expected deficit of 4.9% of GDP, but updated forecasts place the expected deficit at about 5.3% of GDP. This means that, contrary to the original plan, the debt-to-GDP ratio is expected to continue rising in 2026. This follows an increase in public debt from 60.5% of GDP before the war to 68.5% in 2025. The higher debt burden, together with Israel’s higher risk premium, also increases interest costs, which already consume a substantial share of the state budget.

Methodology and Analytical Framework

To assess the budget, we divide state expenditure into three broad categories:

1. Defense expenditure — including both the headline Ministry of Defense budget, but also other defense-related expenditure, of which the biggest item is the intelligence services.
2. Interest payments — including interest on government debt and interest paid to the National Insurance Institute on funds held by the Treasury.
3. Civilian expenditure — including all other expenditures, such as education, health, infrastructure, higher education, welfare, employment, science, culture, and other civilian services, including internal security.

This division allows us to examine the core fiscal tradeoff facing Israel: how much the state spends on defense, how much it pays for past borrowing, and how much remains for services and investment for citizens.

Our analysis is based on the net state budget (central government), as reflected in The Budget Key (“Mafteach HaTakziv” – a budget transparency database). Up to 2024 we use budget-execution data; 2025 data reflect the budget after changes approved by the Finance Committee; and 2026 data are based on the budget approved by the Knesset in March 2026, after the additional defense spending following the renewed confrontation with Iran was incorporated. Budget aggregates are presented mainly as a share of GDP in order to allow comparison across years and policy scenarios.

We also examine the implications of alternative defense-spending scenarios for the coming decade, including a scenario based on the Nagel Committee’s recommendations and higher expenditure scenarios based on the Prime Minister’s stated plan. We compare these paths with Israel’s fiscal rules, debt dynamics, tax burden, and the scope of civilian expenditure that would remain available under different assumptions.

The 2026 Budget: Main Findings

The 2026 budget reflects, first and foremost, the heavy fiscal cost of years of war. Defense spending has risen dramatically compared with the prewar period. In 2022, defense expenditure stood at about 4.2% of GDP; in 2026 it is expected to almost 8% of GDP. In budget-share terms, defense expenditure has risen from 16% of the state budget in 2022 to about one quarter of the budget in 2026. Total defense spending in the budget is estimated at roughly NIS 175 billion, including the Ministry of Defense, other defense expenditures, and a reserve for war-related needs.

This increase is the central constraint on the state budget. It comes on top of a rising interest burden and a deficit that remains high. The result is that Israel is spending more on security relative to the size of its economy, while its debt is expected to rise further. The fiscal space that existed before the war has narrowed, and the budget no longer provides a credible path toward stabilizing and then reducing the debt ratio.

At the same time, civilian expenditure is under growing pressure. Israel’s civilian expenditure was already very low by international comparison before the war. Civilian expenditure excluding interest is about 10 percentage points of GDP lower than the median among advanced OECD countries — a gap equivalent to roughly NIS 220 billion in 2026 terms. This gap is reflected in public services, infrastructure, health, education, mental health, public transportation, and the state’s ability to support citizens in times of need.

Although civilian expenditure has increased as a share of GDP since the outbreak of the war, this increase does not represent a meaningful improvement in ordinary public services. Much of it reflects emergency and reconstruction needs, including civilian war reserves, the Tekuma (Reconstruction) Administration, and northern rehabilitation programs. Once these emergency components are taken into account, the regular civilian budget is beginning to erode.

This erosion is especially visible in real expenditure per resident. Between the 2025 and 2026 budgets, real civilian expenditure per capita is expected to decline by about 3.3% overall, and by about 6% when excluding “other expenditures,” which rose because of civilian reconstruction and emergency needs. Declines are expected in core areas such as infrastructure, National Insurance transfers, education, welfare, higher education, employment, and science, culture, and sports.

The erosion of civilian capacity is also reflected in public-sector wages. In recent years, the gap between business-sector wages and public-service wages has widened sharply. By the end of 2025, the average wage in the public services had fallen to about 75% of the business-sector wage (or about 10% after accounting for workers' education and experience). This creates a growing risk of recruitment and retention difficulties in the public sector, especially in high-demand professions, and may weaken the quality of public services over time.

Sectoral Spending and Budget Priorities

Even under the severe fiscal constraints created by the war, the 2026 budget continues to include substantial coalition and sectoral allocations. We define sectoral budgeting not as any expenditure directed toward a specific population, but as expenditure directed to specific groups without a professional justification, without serving the government’s long-term goals, or even contrary to professional recommendations.

The budget includes approximately NIS 5 billion in coalition funds with sectoral characteristics, including allocations for yeshivas, food vouchers that were previously distributed according to sectoral criteria, and after-school programs in institutions that do not teach core curriculum subjects. In addition, about NIS 300 million in sectoral allocations were incorporated into the permanent budget base, including funding for religious buildings, Jewish-identity programs, and settlements.

This development is especially concerning because incorporating such funds into the budget base makes them permanent and less transparent. We identify a broader effort to minimize the formal classification of sectoral allocations as “coalition funds,” thereby reducing public scrutiny while preserving the spending. In the case of the budgeting of the Haredi political parties' affiliated education networks, the government did not address particular concerns regarding weak oversight, reliance on self-reporting, legal irregularities, and funding for institutions that do not provide the skills required for labor-market integration and discourage military service.

The problem is not only the size of these allocations, but their opportunity cost. At a time when Israel faces major reconstruction needs, rising defense expenditure, growing interest payments, and pressure on civilian services, public resources should be allocated according to professional, national, and growth-enhancing considerations. Instead, the budget continues to direct meaningful sums to narrow sectoral purposes. This also harms trust in government.

Growth Engines and Long-Term Economic Capacity

Israel’s ability to carry a higher defense burden depends on its ability to grow. In previous decades, Israel was able to increase defense spending in real terms while reducing defense expenditure as a share of GDP because the economy grew faster than the defense budget. This experience demonstrates why investment in growth engines is not only an economic priority but also a national-security interest.

The 2026 budget does not provide a sufficient response to this challenge. Investment in key growth engines remains too low. Higher education has declined as a share of GDP compared with the prewar period. Employment-related spending remains low. Transport infrastructure investment is insufficient relative to Israel’s large infrastructure gaps and growing population. The level of investment in education, research, infrastructure, and labor-market integration does not match the needs of an economy that must finance a larger permanent defense burden.

One central issue is the integration of minority populations into quality employment. In Arab society, previous five-year development plans helped narrow gaps and supported growing integration into education and employment, especially among women. These programs were assessed by professional bodies as effective and economically worthwhile. Yet in recent years the government has cut Arab-society development budgets disproportionately, including cuts to local-authority and economic-development programs. These cuts risk reversing progress and harming not only equality but also future growth.

In Haredi society, the challenge is different. There has been a stagnation in employment rates among Haredi men and low wages and part-time employment among Haredi women. Because many Haredi households pay relatively little in direct taxes while consuming public services, current trends pose a substantial long-term fiscal challenge. Continuing to fund education systems that do not teach core curriculum subjects at the required level, do not prepare graduates for quality employment, and do not encourage military service is inconsistent with Israel’s long-term fiscal and growth needs.

The issue of military service also has major fiscal implications. A broader enlistment of Haredi men could reduce reliance on reserve soldiers, whose cost to the economy is much higher than that of regular conscript soldiers. Bank of Israel estimates suggest that enlistment of 7,500 Haredi men per year could generate annual savings of about NIS 9 billion within three years.

The Coming Decade: Defense Spending and Civilian Erosion

An examination of what Israel’s budget would look like in the coming decade under expected defense-spending scenarios suggests that even if the war ends and Israel returns to relative routine, defense spending is expected to remain significantly higher than before October 7. The Nagel Committee recommended a substantial increase in the defense budget over the coming decade, while the Prime Minister’s plan points to an even larger increase.

Even under the more moderate Nagel Committee scenario, the fiscal burden would be heavy. If Israel were to comply with its existing fiscal rules (which relaxed substantially in the past few years, in accordance with the tax increases) while financing the higher defense budget, civilian expenditure would decline significantly. Under these assumptions, civilian budget expenditure would fall by about 2 percentage points of GDP over a decade, and real civilian expenditure per capita would decline by about 5% in the short term, even assuming stable growth and no further major security shocks.

This is not a sustainable path. Israel already has low civilian expenditure, large infrastructure gaps, urgent reconstruction needs, and underinvestment in human capital. Further erosion in civilian expenditure would harm public services, weaken growth engines, reduce public trust, and ultimately make it harder to finance the defense burden itself.

A Proposal for an Alternative Fiscal Path

We therefore propose an alternative fiscal path for the coming decade. The path is based on three principles:

First, rebuilding public trust.
Public willingness to support higher taxes depends on confidence that additional revenue will be used to improve services for the general public. Rebuilding this trust requires cutting sectoral and growth-inhibiting budgets, ensuring that public spending is allocated according to professional criteria, and directing resources to universal and growth-enhancing services.

Second, gradually increasing the tax burden and base.
Israel’s tax burden is low relative to advanced OECD countries. We recommend gradually raising it to the median level among advanced OECD countries by 2029. This increase should focus on broadening the tax base, reducing inefficient tax benefits, and minimizing harm to incentives. It should not rely solely on the population groups already bearing most of the tax burden.

Third, increasing civilian expenditure in a responsible way. A substantial share of the increased tax revenue must be directed toward improving civilian services and investing in growth engines. This includes infrastructure, education, higher education, research and development, employment, and public-sector capacity.

Under this proposed path, the broad-government deficit would decline gradually to 2.5% of GDP by 2029, rather than to 1.5% as currently set in law. This would still allow the debt-to-GDP ratio to begin falling gradually, from around 68% in 2026 to about 65% by 2036. At the same time, it would prevent a collapse in civilian expenditure and allow for a moderate increase in public investment and services.

Priorities for Higher Civilian Expenditure

The increase in civilian expenditure must be targeted and efficient. We identify several priorities:

Infrastructure. Israel must maintain high investment in infrastructure, especially public transportation, in order to narrow the gap with advanced countries. This includes heavy rail, light rail, metro systems, and improved bus services, alongside better planning, execution capacity, metropolitan transport authorities, and diversified funding mechanisms.

Education. Israel should invest in a longer school day that serves the general public, improve teacher pay in a differentiated manner, and reduce gaps in both Jewish and Arab education systems. Education policy must also support the integration of Haredim into employment.

Higher education and research. Israel must increase investment in academic education and basic scientific research in order to prevent erosion in its research capacity and preserve its long-term comparative advantage.

Bringing the budget closer to citizens. Where local authorities have the capacity to provide services effectively, authority should be brought to the local level in areas such as welfare, education, and transportation. This could improve service quality and strengthen the legitimacy of tax payments.

Public-sector wages and capacity. Given the widening wage gap between the public and business sectors, Israel should improve public-sector compensation in a way that rewards performance and excellence, helps attract and retain high-quality workers, and strengthens service delivery.

Conclusion

The 2026 budget is the fourth budget year shaped by the burden of war. It reflects the heavy costs of the security reality, but it does not yet provide a responsible long-term response to them. The budget raises defense spending sharply, allows debt pressure to continue, erodes civilian services in real per-capita terms, and preserves substantial sectoral allocations. It does not sufficiently protect growth engines or offer a credible path for improving services to citizens.

Israel needs a different budgetary strategy: one that recognizes the new defense burden but does not allow it to consume the foundations of long-term prosperity. This strategy must combine disciplined defense planning, gradual debt stabilization, a broader and fairer tax base, cuts to sectoral and growth-inhibiting spending, and a measured increase in civilian expenditure directed toward growth, public services, infrastructure, and social integration.

Only such a path can allow Israel to meet its security needs while preserving fiscal stability, improving services to citizens, narrowing social and infrastructure gaps, and sustaining long-term economic growth.

The full study is available in Hebrew here.