JERUSALEM (Reuters) - Israel's cabinet on Tuesday approved the 2013-2014 budget draft that will slash spending and hike taxes this year and next to rein in a growing budget deficit.
Cabinet ministers approved the 17-month state spending package 21-1 with cuts of at least 25 billion shekels ($7 billion) between August 2013 and the end of 2014. Defense spending was cut by 3 billion, down from a proposed 4 billion.
Finance Minister Yair Lapid had warned that failure to implement public spending cuts could cause an economic collapse. Tax increases starting in 2014 are expected to bring in some 13.4 billion shekels.
Lapid said the vote was "a first stage in changing peoples' lives in Israel".
The budget will appease the Bank of Israel, which has called for a return to fiscal responsibility, but has angered middle-class voters whose strained household finances were a major issue in January's election.
The central bank took financial markets by surprise on Monday with a rare between-meetings interest rate cut to halt the shekel's rally and to support the weakening economy.
The quarter-point cut took its benchmark interest rate to 1.5 percent.
Israel's budget deficit was 4.2 percent of gross domestic product (GDP) last year - more than double its initial target -due to overspending by the previous government and lower-than-expected tax revenues as the economy slowed.
Indecision over how to tackle the deficit brought down the previous government. That triggered January's poll and catapulted Lapid, a centrist who campaigned on promises that the middle class's economic burden would fall, into Netanyahu's right-leaning coalition government.
Last month, Lapid raised the 2013 budget deficit target to 4.65 percent of GDP from 3 percent. The 2014 target was lifted to 3 percent of GDP from 2.75 percent.
He had wanted a 4.9 percent target this year but backtracked after Standard & Poor's cut Israel's local currency sovereign credit rating, citing "recent fiscal slippage".
The draft budget is expected to increase income tax by 1.5 percentage points, value-added tax to 18 percent from 17 percent, and corporate tax to 26 percent from 25 percent. Other cuts include child allowances and public sector jobs.
Total spending in 2013 will be 388 billion shekels, rising to 408 billion in 2014.
Parliament needs to debate and approve the budget by the end of July for it to come into effect.
($1 = 3.61 shekels)
(Writing by Ori Lewis; Editing by Louise Ireland)