Defence Economies at War: National Budget Stress

A defence economy comprises the fiscal, industrial, and budgetary systems through which a state finances, maintains, and adjusts its military capacity. During peacetime, these systems tend to remain stable; in wartime, they become the main mechanism through which conflict transforms a nation’s economic structure. The escalation of Israeli military operations since October 2023 and the broader confrontation with Iran and its regional proxies have caused a defence-economy shift, leading to significant realignments in how the conflicting sides allocate public resources, incur debt, and prioritise expenditure.

This analysis examines how sustained military escalation has reshaped the defence economies of its three key actors: Israel, Iran and the United States. It assesses both short-term fiscal responses and longer-term budget trajectories, arguing that the conflict has not produced a temporary spending spike but a structural transformation, one that has widened deficits, crowded out civilian services, mobilised domestic defence industries, accelerated sovereign credit deterioration, and embedded elevated military spending into national budgets in ways that will persist well beyond any ceasefire. Across the Middle East, the boundaries between battlefield expenditure and national economic health have become increasingly difficult to separate.

Before the escalation that began in October 2023, the defence budgets of Israel, Iran, and the United States (U.S.) reflected three distinct security and fiscal models. Israel maintained a technologically advanced but relatively stable military budget supported by long-standing U.S. assistance. Iran operated under severe sanctions constraints, relying on a combination of formal defence spending and opaque financing mechanisms linked to the Islamic Revolutionary Guard Corps (IRGC). The U.S., meanwhile, remained the world’s largest military spender, with a global defence posture that included sustained security commitments to Israel.

Israel maintained a steady but significant defence posture in this period, spending $27.5 billion on its military in 2023, representing 5.3% of GDP, sustained largely by robust U.S. military aid and a well-developed domestic defence industry anchored by firms such as Elbit Systems, Rafael, and Israel Aerospace Industries. Iran’s profile was markedly constrained by economic sanctions, with total official expenditure of $10.3 billion in 2023. However, its true military footprint was considerably larger due to the IRGC’s extensive off-budget financing mechanisms, a structural opacity that would become increasingly consequential as the conflict intensified. These structural conditions collectively established a volatile fiscal baseline, primed to shift sharply once large-scale conflict erupted. These fiscal structures formed the baseline from which wartime spending expanded. The escalation that began in October 2023 rapidly transformed these established defence budgets, triggering emergency appropriations, supplemental spending, and longer-term fiscal adjustments across all three actors.

The contrast with the 2025–2026 period is stark. Global military expenditure reached $2.7 trillion in 2024, marking the steepest year-on-year increase since the end of the Cold War, with particularly strong growth in Europe and the Middle East. Regional military spending rose to an estimated $243 billion, a 15% increase from 2023, reflecting intensifying security tensions.

Within this broader trend, Israel’s defence expansion has been particularly pronounced. By 2025, military spending had reached approximately $32.7 billion, equivalent to roughly 9% of GDP, nearly double its pre-war share. However, the escalation with Iran has pushed defence spending well beyond initial projections for 2026. While the budget was originally set at $34.6 billion, the final budget approved by the Knesset allocates approximately NIS 143 billion (around $45.8 billion) to the Ministry of Defense, marking the largest defence allocation in Israel’s history. This expansion has been accompanied by significant wartime expenditures, with the conflict already costing an estimated $11.5 billion in budgetary terms.

Beyond headline figures, Israel has intensified investment in domestic defence production and procurement to sustain operational capacity. This includes new contracts with firms such as Elbit Systems, alongside the rapid establishment of large-scale logistical supply chains. According to the Ministry of Defense, approximately 200 cargo aircraft delivering around 8,000 tons of military equipment have arrived within a single month, underscoring the scale of material consumption and replenishment. Much of this expansion is being financed through a widening fiscal deficit, embedding elevated defence spending more deeply into Israel’s economic structure. While Israel’s trajectory reflects the fiscal burdens of sustained conventional warfare, Iran’s military financing continues to rely on a contrasting model shaped by sanctions and asymmetric strategy.

Iran’s trajectory has been no less significant, though it remains shrouded in the same opacity that characterised the earlier period. Its military budget for 2025 surged to an estimated $23.1 billion, a 35% increase from the prior year, with $12.36 billion allocated through official budget lines and an additional sum funnelled through oil quotas and special project credits that lack transparency. Iran announced a 200% increase in its military budget in October 2024, signalling its intent to maintain a strong defensive and offensive posture and demonstrating that sanctions have not deterred its military ambitions. This expansion is occurring alongside mounting macroeconomic pressures: elevated inflation continues to erode purchasing power, the Iranian rial has experienced persistent depreciation, and heavy reliance on oil revenues exposes fiscal stability to external shocks and sanctions enforcement. As a result, Iran’s defence expansion is increasingly financed through a sanctions-adjusted fiscal deficit, where off-budget channels and energy-linked revenues compensate for constrained formal state resources. These figures confirm that the pre-2023 baseline was not a ceiling but a floor: the region has entered a phase of sustained, conflict-driven militarisation that shows little sign of abating.

The fiscal consequences of Israel’s multi-front war have been immediate and historically significant. As mentioned, in 2025 military spending reached approximately $32.7 and earlier in 2024 billion Military expenditure surged by 65% to approximately $46.5 billion in 2024 which is the steepest annual increase since the Six-Day War in 1967, raising defence spending to 8.8% of GDP, up from 5.3% in 2023, placing Israel second only to Ukraine globally in defence spending as a share of economic output. Israel’s official defence budget reached around $30.5 billion in. The operational tempo was relentless: $5.7 billion was spent on defence in December 2024 alone. A significant share of costs stems from Israel’s missile defence architecture, where each Iron Dome interceptor costs roughly $50,000 and an Arrow-3 interceptor up to $2.5 million, creating a pronounced cost asymmetry against Iranian ballistic missiles, which cost between $200,000 and $500,000 to produce.

The wartime surge carried severe consequences for Israel’s fiscal standing. The budget deficit narrowed to 4.7% of GDP in 2025, beating the 5.2% target; the passage of the Iran war supplement in March 2026 is expected to widen the 2026 deficit materially beyond earlier projections of 3.9% of GDP, though the precise revised ceiling is subject to ongoing budget negotiations. Despite the ongoing war in 2024 as for 2024 the budget deficit widened to 6.9% of GDP in 2024, far exceeding the government’s original 2.25% target, while public debt climbed toward 70% of GDP, levels not seen since the early 2000s. Sovereign credit markets reacted swiftly: Moody’s downgraded Israel’s credit rating twice within fourteen months, first from A1 to A2 in February 2024 and again to Baa1 in June 2025, citing ongoing military conflict, rising defence expenditures, and deepening fiscal uncertainty. Wartime spending simultaneously displaced civilian priorities: the 2024 budget introduced a 3% reduction in overall government spending, with cuts to welfare, education, and healthcare, while a VAT rise and higher insurance premiums fell disproportionately on lower-income households. The 2025 budget implemented a further 5% cut in civilian spending alongside a VAT increase from 17% to 18%. The Bank of Israel estimated total war expenses from 2023 through 2025 at NIS 220 billion, excluding broader revenue losses.

Israel’s domestic defence industry simultaneously underwent rapid mobilisation to reduce reliance on foreign supply chains. Elbit Systems, Rafael, and IAI dramatically expanded production lines for munitions, drones, and missile interceptors, with Elbit reporting a record order backlog exceeding $21 billion by mid-2024. This industrial scaling offered a partial offset to import dependency but required substantial state-backed investment, further compounding Israel’s long-term debt trajectory. While Israel’s defence expansion reflects the fiscal pressures of direct conventional warfare and large-scale mobilisation, Iran’s military financing structure operates under a markedly different economic model shaped by sanctions, indirect warfare, and off-budget funding channels.

Iran’s fiscal response differs fundamentally from Israel’s, reflecting the constraints of a sanctions-battered economy combined with a strategic preference for asymmetric, off-budget warfare. Sanctions have constrained Iran’s formal state budget, incentivising the development of parallel financing channels controlled by the IRGC, including energy exports, construction conglomerates, and commercial holdings. Official military spending decreased by 10% in 2024 to $7.9 billion, even as affiliated armed groups; Hezbollah, Hamas, and the Houthis, were engaged across multiple active fronts. Alternative analyses place Iran’s true 2024 defence allocation at $16.7 billion, approximately 25% of the national budget, with the gap explained by the IRGC’s self-financing through commercial entities in construction, transportation, and oil extraction. This structure allows Tehran to sustain regional military activity while insulating the formal state budget from sanctions-induced fiscal constraints. Since 2012, Tehran is estimated to have spent over $20 billion supporting foreign armed groups. A single ballistic missile salvo on 1 October 2024, involving approximately 180 missiles, cost Iran an estimated $36 million to $90 million to execute. While this highlights a stark financial asymmetry when compared to the estimated $2.3 billion it cost Israel and its allies to intercept the barrage, conducting such direct conventional strikes remains highly resource-intensive for Tehran relative to its traditional, lower-cost proxy warfare model. . The third major fiscal actor in the conflict is the United States. Unlike Israel and Iran, whose defence spending reflects direct operational requirements, the U.S. role is primarily expressed through strategic military assistance, logistical support, and the replenishment of allied defence systems.

The US has functioned as Israel’s primary fiscal underwriter. Since October 2023, Washington has enacted legislation providing at least $16.3 billion in direct military aid, including an $8.7 billion supplemental act in April 2024 with $6.7 billion for missile defence. Total U.S. military assistance amounts to at least $21.7 billion when broader security assistance is included. A significant and underreported dimension of this burden is stockpile depletion: by May 2025, the U.S. had delivered 90,000 tons of arms and equipment via 800 transport planes and 140 ships, requiring additional congressional appropriations to replenish depleted War Reserve Stocks and restore US readiness for contingencies elsewhere. Reflecting this rapidly escalating financial burden, the Pentagon formally requested White House approval for an emergency supplemental funding package exceeding $200 billion, a figure that itself had rapidly superseded an earlier estimate of $50 billion floated in early March 2026. By March 19, the U.S. had already spent an estimated $18 billion on the conflict alone, with operations costs totalling roughly $11 billion in just the first week of strikes. This massive appropriation is primarily designed to replenish critical munitions shortfalls, rebuild depleted stockpiles, and cover military expenditures sustained during direct confrontation with Iran, with the Pentagon signalling the funds would cover both what has been spent and what may be required going forward. With estimates confirming the operational costs of the conflict are running at approximately $1 billion per day, this funding requirement underscores how the war is imposing unprecedented fiscal pressures, compelling Washington to make structural adjustments that stretch far beyond its standard defence baseline.

Taken together, the fiscal responses of Israel, Iran, and the United States illustrate how sustained conflict reshapes national budget priorities beyond immediate wartime spending. These developments provide the foundation for understanding the longer-term structural transformation of defence economies discussed in the following section.

The longer-term budget outlook suggests that the escalation since October 2023 represents not a temporary fiscal shock but a structural transformation of Middle Eastern defence economies. War has reshaped fiscal priorities in ways that will persist for the remainder of the decade. The post-1973 period in Israel and the Iran–Iraq War of the 1980s demonstrate that defence allocations rarely return fully to pre-crisis levels and the present conflict shows every sign of following the same trajectory. The key mechanism is institutional lock-in: wartime budget expansions create entrenched procurement programmes, expanded military establishments, and political constituencies resistant to post-conflict drawdowns.

For Israel, expenditures are widely expected to remain in the 7–8% of GDP range through the latter half of the decade, requiring sustained investment to replenish interceptor inventories, expand missile defence coverage, and modernise air and cyber capabilities. The credit downgrades and debt accumulation of 2024–2025 will constrain fiscal flexibility, creating difficult trade-offs between defence investment and social spending for years to come. The U.S. will face continuing fiscal obligations through stockpile replenishment and long-term assistance commitments, even as domestic political debates over foreign aid create uncertainty around future appropriations. This burden must be understood against a Pentagon base budget that has already crossed $1 trillion for FY2026, following an additional $150 billion injected through the 2025 reconciliation bill, making the $200 billion supplemental request not an isolated emergency measure but an addition to an already historically elevated defence baseline. Iran will maintain its reliance on asymmetric and off-budget financing, enabling the IRGC to sustain regional proxy networks without straining the formal state budget, a model that proved resilient under the pressures of 2024 and is unlikely to change.

For Iran, the long-term trajectory reflects a structurally constrained but adaptive defence economy. Persistent inflation, currency depreciation, and limited access to global capital markets will continue to restrict formal fiscal expansion, reinforcing reliance on oil-linked revenues and off-budget financing through the IRGC. This model allows Tehran to sustain military and proxy activities while masking the true fiscal burden, but it also entrenches economic distortions, including a widening gap between official and real expenditures and continued vulnerability to oil price volatility and sanctions pressure. Over time, this hybrid system is likely to institutionalise a dual-track defence economy, where formal budget limitations coexist with sustained, opaque military financing.

Ultimately, the escalation of conflict in the Middle East since October 2023 has fundamentally reshaped the defence economies of Israel, Iran and the U.S. increases Military expenditure across those three actors demonstrate that wartime fiscal expansion is no longer a temporary response but a structural shift in national budget priorities. Israel’s dramatic rise in defence spending, Iran’s reliance on opaque and off-budget financing, and the U.S.’s growing financial commitments collectively illustrate how conflict reshapes fiscal architecture. As defence burdens expand and civilian spending pressures intensify, governments face difficult trade-offs between security and economic stability. The enduring lesson is clear: once militarisation becomes embedded in fiscal planning, reversing it becomes politically and economically difficult.

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