September 2013

PALESTINE: MILLIONS OF DOLLARS IN REVENUE “LEAKED” TO ISRAEL

Palestine loses at least $300 million in “leakages” to Israel each year.

By Kanaga Raja

Third World Network Features

The Occupied Palestinian Territory (Palestine) is losing some $300 million annually as a result of revenue "leakage" from direct and indirect imports and from smuggling from or via Israel, the United Nations Conference on Trade and Development (UNCTAD) has said.

In a report for the upcoming sixtieth session of its Trade and Development Board taking place later this month, the UNCTAD Secretariat stressed that had these revenues been transferred by Israel to the Palestinian Authority, Palestinian tax revenue would have increased by 17%, covering 18% of the public wage bill.

In addition, Palestine’s Gross Domestic Product (GDP) would increase by 4% and employment by 10,000 jobs per year.

According to the UNCTAD report on assistance to the Palestinian people, the strains on the Palestinian economy have intensified since 2012, with GDP growth slowing to 6% in 2012, down from double-digit growth in the previous two years, while unemployment soared to 27 per cent.

"Structural constraints on economic development have worsened due to the prolonged Israeli restrictions on the movement of Palestinian people and goods, the expansion of settlements, the growing inability of Palestinian producers to access their productive resources, the decline in aid flows and pervasive political and economic uncertainty," it said.

It noted that the deepening fiscal crisis triggered political unrest in Palestine, and hopes for a political settlement dimmed further.

The projected decline in economic performance is a natural result of the increasingly binding constraints on both the supply and the demand sides of the economy. The feeble economic performance reflects the impact of the fiscal crisis and lower aid flows on aggregate demand.

On the supply side, growth is sharply constrained by the blockade on Gaza, mobility and access restrictions and the construction of the separation barrier in the West Bank, isolation of the whole economy from international markets, inflated production costs that cripple competitiveness and deteriorating political horizons.

Previously, the effects of these restrictions had been masked by significant donor support, which enabled the Palestinian Authority to inject fiscal stimulus into the economy. The decline in accustomed aid inflows and the ensuing fiscal crisis have begun to reveal the full impact of the Israeli occupation on the Palestinian people and their economy.

According to the report, the deceleration of economic activities was pronounced in Gaza, where GDP growth fell from 21% in 2011 to 6.6% in 2012. This decline, concentrated in the agricultural and fishing sectors, was due to the Israeli military operation on Gaza in November 2012, acute energy and water shortages, unfavourable weather and the Palestinian Authority's fiscal crisis.

Even in the West Bank, previously higher economic growth slowed to 5.6%, mainly because of the contraction of the construction sector (4.2 per cent).

Unemployment rose to 27% in 2012, said UNCTAD, adding that unemployment and participation rates are worst among young Palestinians, with one out of two unemployed in Gaza.

"Prolonged episodes of high unemployment will inevitably produce long-lasting socioeconomic costs because the large-scale de-skilling of workers renders some of them not just unemployed but unemployable."

The large, persistent Palestinian trade deficit worsened in 2012, rising 12.5% from $4.3 billion to $4.8 billion between 2011 and 2012.

Export growth was too weak to keep up with the 10% increase in imports. At $1.7 billion, exports barely covered one quarter of the import bill. The 7% share of goods export in GDP is among the lowest in the world.

According to UNCTAD, these exports originate almost entirely from the West Bank as Gaza remains under tight blockade.

Another salient feature of Palestinian foreign trade is the forced dependence on the Israeli economy. Restrictions and the high cost of trade with the rest of the world have left Israel as the only viable foreign market for Palestinian exports and imports. This maintains a long-standing skewed concentration of Palestinian trade with Israel, which is the source of most of the restrictions imposed on Palestine.

This structural dependence continued in 2012 as Israel accounted for 70% of Palestinian imports, and absorbed more than 80% of its exports, leaving a bilateral trade deficit of $3.7 billion, equivalent to 77% of the total Palestinian trade deficit and 37% of GDP.

The report said that the restrictive measures imposed by the occupation authorities have reinforced the Palestinian fiscal crisis from both the revenue and expenditure sides.

On the revenue side, the weak economic activities, fragile private sector and below-potential output levels have reduced the tax base and restricted the Palestinian Authority's capacity to raise revenue.

On the expenditure side, the ensuing economic decline and associated high poverty and unemployment rates have put pressure on the Palestinian Authority to increase its spending on social services and transfers to mitigate the large-scale impoverishment and recurrent humanitarian crises.

"In the meantime, the suffocated private sector is incapable of job creation and has thus forced the Palestinian Authority to act as an employer of last resort to absorb a portion of the growing labour force."

In 2012, UNCTAD noted, the Palestinian Authority suffered its most serious fiscal crisis since 2006. Revenues were below projections, donor aid fell, Palestinian Authority payments arrears to the private sector continued to accumulate and loans from domestic banks rose to $1.4 billion (68% of revenue).

Clearance revenue is the largest source of Palestinian public revenue, as it accounts for 70 per cent of total revenue, and covers 84 per cent of the public wage bill and 45 per cent of current expenditure. It is composed of revenue from tariffs and value added taxes (VAT) on Palestinian imports transiting Israel, which Israel collects on behalf of, and then transfers to, the Palestinian Authority.

"This arrangement gives Israel leverage over the Palestinian Authority, leaving it hostage to political pressure. Fiscal vulnerability has developed from Israel's repeated delaying or withholding of clearance revenue over the years. The latest episode of delayed clearance revenue, an average of $120 million a month, occurred following the successful bid for the recognition of the State of Palestine as a non-member observer State by the United Nations in November 2012."

According to UNCTAD, the disappointing results of the Palestinian Authority's attempts at fiscal reform are testimony to the futility of autonomous economic policymaking under occupation.

"Achieving fiscal independence and ending structural dependence on aid will continue to be a mirage as long as Gaza remains under blockade, access and movement restrictions in the West Bank persist, public and private investment in Area C [under Israeli control] are restricted and sovereignty is denied."

Although the donor community has provided significant support to the Palestinian people in recent years, it remains true that as fiscal pressure on the Palestinian Authority mounts, it is inevitable that the dependence on unpredictable and unsustainable aid flows will deepen.

"UNCTAD has long affirmed that aid - essential as it has been for relief, sustaining the Palestinian Authority and preserving the economy from collapse - is not a substitute for sovereignty over land, borders, trade and economic policymaking."

Focusing on the issue of the Palestinian revenue leakage, the report noted that Palestinian trade taxes consist of purchase tax and VAT, levied on all imports, whether they originate from Israel or elsewhere, as well as additional excise tax and custom duties on imports from sources other than Israel. The Paris Protocol (signed by Israel and the Palestine Liberation Organisation in 1994) stipulates that trade between Palestine and Israel be exempted from custom duties, but subject to VAT and purchase tax.

According to UNCTAD, the term ‘fiscal leakage' here refers to Palestinian fiscal revenues destined for the Palestinian Authority, as stipulated by the Paris Protocol, but retained by the Israeli Treasury instead.

Focusing on leakage from Palestinian imports from Israel or products smuggled into Palestine from Israel, the report said that according to the Paris Protocol, any product that has been wholly produced in Israel or has more than 40% of Israeli value added is exempted from Palestinian customs duties, but not from VAT or purchase taxes.

However, it has been argued that not all Palestinian imports from Israel are goods produced in Israel or meet the rule of origin. A significant portion of these imports are produced in a third country, cleared as Israeli imports before being sold in Palestine as if they had been produced in Israel. They are known as indirect imports, to differentiate them from direct imports that meet the rule of origin.

Based on data from the Bank of Israel (2010), UNCTAD assumes that 39% of recorded imports from Israel originate from the Israeli commercial sector, and could therefore be considered indirect imports.

Customs revenue from these indirect imports is collected by the Israeli authorities but not transferred to the Palestinian Authority, as they are not labelled as being destined for Palestine and are imported by Israeli importers and resold to Palestinian consumers. Further, the Palestinian Treasury does not receive from Israel the purchase taxes on all imports from Israel. The third element of fiscal leakage from imports from Israel is the VAT revenue that is applied to the leaked purchase tax and customs duties on indirect imports.

According to UNCTAD, it is estimated that some $115 million per year of revenue from direct and indirect imports from Israel were not transferred to the Palestinian Authority in 2010 and 2011.

Smuggling is another source of significant fiscal revenue loss. Where the smuggled goods are produced in Israel, the Palestinian Authority loses VAT and purchase tax revenue. However, where goods are produced in a third country, tariff revenue is also leaked along with VAT and purchase tax revenue.

Records of customs controls, for example, show that there were 11,967 unsuccessful smuggling attempts between 2009 and 2011. The value of would-be smuggled goods caught by the Palestinian Authority in 2010 and 2011 was $240 million. Data for 2010 and 2011 suggest that the estimated revenue leakage from smuggling amounts to about $190 million per year.

By adding up the leakage from total imports and smuggling from Israel, the estimated total leakage from these items alone is more than $300 million per year, said the report.

UNCTAD however sounded a note of caution, saying that these estimates are moderate, as they do not account for the total aggregate of economic losses accumulated through the other fiscal leakage sources, which are not covered by the study but should be pursued vigorously by further technical investigations.

These other sources include: (a) Leakage of revenue from taxes levied by Israel on the incomes of Palestinians working in Israel and settlements; (b) Seigniorage revenue loss from using the new Israeli shekel in Palestine; (c) Revenue loss from underpricing imported goods in invoices, owing to the lack of Palestinian control over borders and access to proper trade data; (d) Revenue loss related to lack of control over land and natural resources; (e) Financial resources loss related to goods and services imported through the Palestinian public sector, such as petroleum, energy and water; (f) Loss of customs revenue on goods finished in Israel but with less than 40% of Israeli content as required by the rules of origin established by the World Trade Organisation; (g) Fiscal loss as a result of the smaller tax base caused by the decimation of the productive base and loss of natural resources to occupation.

UNCTAD recommended a number of measures to contain fiscal resources leakage, including replacing the Paris Protocol with a balanced framework consistent with the needs for Palestinian fiscal independence, structural transformation prerequisites and sovereign economic policymaking.

It stressed that the Palestinian resource leakage is rooted in the trade relations between Palestine and Israel enshrined in the Paris Protocol, which deprives the Palestinian Authority of policy independence, border control and the ability to collect accurate data on external trade.

"The Protocol curtails the Palestinian Authority's ability to conduct industrial policies and limits Palestinian fiscal space by forcing the Palestinian Authority to adhere to Israel's tariff schedule, which is not compatible with the vastly different Palestinian economy," it added. – Third World Network Features.

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About the author: Kanaga Raja is the Editor of South-North Development Monitor (SUNS).

The above article is reproduced from SUNS #7649, 9 September 2013.

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