December 2014

PALESTINE LOSES MILLIONS OF DOLLARS A YEAR TO ISRAEL

Between 2010-2011, it is estimated that the total annual average fiscal leakage amounted to be around $306 million or 3.6% of GDP and more than 17% of the tax revenues collected by Palestine.

By Kanaga Raja

            The Occupied Palestinian Territory (OPT) is losing at least $306 million annually in fiscal leakage to Israel resulting from direct and indirect importing from or through the Israeli market and the evasion of customs duties, a new study by the United Nations Conference on Trade and Development (UNCTAD) has said.

              The study, titled "Palestinian Fiscal Revenue Leakage to Israel under the Paris Protocol on Economic Relations", finds that the estimated costs to the OPT of this annual lost revenue which is not transferred to the Palestinian treasury by Israel is equivalent to 17% of total tax revenue, in addition to 4% in lost GDP and about 10,000 jobs per year.

              According to UNCTAD, the study is the first analytical attempt to address this topic by using a statistical methodology based on a sequential series of official data from multiple complementary sources, and it also aims to settle the continuing controversy over fiscal leakage estimates.

              However, the study did not explore the following points: financial leakage from direct taxes imposed by Israel on the income of the Palestinian labour force working in Israel and Israeli settlements; monetary aspects and losses incurred by use of the dominant Israeli currency; tax evasion through undervaluation in declaration of the actual value of imported goods; fiscal losses on flows of services and goods imported by the Palestinian public sector from Israel such as petroleum, electric power and water; and a range of fiscal losses resulting from the lack of sovereignty over natural resources such as land, water and minerals.

              The study notes that the Protocol on Economic Relations, also known as the Paris Protocol, was signed in 1994 between the Palestine Liberation Organization and the Government of Israel, and it remains the general framework that governs Palestinian trade relations and economic, business and tax policies.

              The study focused on the Paris Protocol sections dealing with imports, customs and value added tax (VAT) policies, highlighting its main shortcomings.

            These stem mainly from the fact that the Protocol is outdated and related to a transitional period that was supposed to end in 1999, UNCTAD said.

              As a result, it no longer addresses the current challenges before the Palestinian economy or its prospects within an independent Palestinian State; neither does it mention the lack of Israeli commitment to the terms of the Protocol, such as the obligation to transfer to the Palestinian National Authority its full financial entitlements to the collection by the Government of Israel of purchase taxes and customs duties on Palestinian imports cleared through Israeli ports of entry.

              The study's estimate on fiscal leakage resulting from importing from or through the Israeli market, and the ensuing evasion of customs duties is made on the basis of official Palestinian statistics of total imports from Israel, while customs duties evasion is estimated by identifying relevant percentages and indicators from the available data.
 
            According to the study, the analysis shows that fiscal leakage from the aforementioned sources exceeded $310 million in 2011, equivalent to 3.6% of total gross domestic product (GDP) and 18% of the tax revenue of the Palestinian National Authority.
 
            Around 40% of the fiscal leakage is related to direct and indirect imports from Israel, and the remaining 60% is in the form of evasion of customs duties.

              Since 1967 Israel has been the biggest channel for Palestinian imports and exports, and the main trading partner of Palestine. Data show that the share of Palestinian trade (total imports and exports) with Israel was between 70-90% of total Palestinian trade between 2007 and 2011.

              At the same time, the Palestinian trade deficit with Israel increased from $2.3 billion to $3.2 billion, accounting for 75% of the Palestinian trade deficit.

              The study addressed the negative effects of the Paris Protocol on the fiscal revenues of the Palestinian National Authority, the manner in which the Israeli authorities apply it and the additional constraints unilaterally imposed by Israel.

              It focused on fiscal leakage from the revenue flows that the Palestinian treasury should be able to collect from indirect taxes imposed on Palestinian imports.

              According to the study, total indirect taxes amount to over 85% of total tax revenues of the Palestinian National Authority from two main sources: the first is value added tax (VAT) on all goods including those imported from Israel, and the second is the import tax on goods imported from countries other than Israel.

              The second source is of utmost importance in terms of its contribution to total revenue, amounting to over 40% of total indirect taxes; this figure could rise should imports from Israel be replaced with direct imports from other countries.

              The study argues that the Palestinian treasury has been deprived of many of its legitimate financial resources under the Protocol and has been suffering repeated suspensions and delays in transferring clearance revenues for political reasons.

            It noted that various studies have shed light on the negative effects on the Palestinian economy due to the instability, uncertainty and the loss of portions of the fiscal revenues that leak to Israel.

              Citing previous UNCTAD reports, the study said that the Palestinian National Authority continued its long-term efforts since 2008 to reduce the budget deficit, achieve financial sustainability and reduce dependence on donor aid. These efforts were implemented in an unfavourable environment characterized by declining aid, falling development expenditures and internal political divisions.

            Despite serious efforts by the Palestinian National Authority, the budget deficit continued, and the overall fiscal situation deteriorated as tax revenues failed to increase sufficiently to catch up with expenditures while donor funding remained below expectations.
 
            According to the study, the Palestinian National Authority's fiscal reform succeeded in narrowing the budget deficit by about 11% between 1999 and 2011 to reach 12.4% of GDP.

              During the same period, the revenue of the Palestinian National Authority rose from $1.8 billion to $2.2 billion but remained below projections, owing to well-below-potential GDP growth in the West Bank and revenue-neutral GDP growth in Gaza.
 
            Total current transfers to the Occupied Palestinian Territory - mostly donor funds - reached $2.4 billion in 2011, 27% less than the previous two years. Budget support stood at $980 million, which was half a billion dollars less than the external budget support needs of the Palestinian National Authority for that year.

              "This forced the Palestinian National Authority to borrow from local banks and accumulate arrears to private sector contractors and the pension fund. While the arrears grew to $540 million, debt to local banks increased $140 million to reach $1.1 billion – 50% of total revenues - by the end of 2011."

              In May and November 2011, Israel suspended Palestinian clearance revenues, as it had done in 2002 and 2006, the study noted.

              "Despite the eventual release of the revenues, this practice undermines the economic and financial stability of the Palestinian National Authority, especially since public expenditure is a key source of economic growth and clearance revenues constitute 70% of total revenue."

              Another key element of the Palestinian fiscal crisis is the extremely low development expenditure, which was only $215 million (or 3.4% of GDP) in 2008.
 
            Expenditures on development expanded slightly in 2011 to reach $368 million, or 4.2% of GDP. The long-term costs of consistently low expenditures on development are high in light of the multiple constraints and weakened Palestinian production base.

              The taxation system and trade regime enshrined in the Paris Protocol impose losses through the leakage of resources to Israel and lack of sovereignty in collecting taxes and generating accurate taxation data to enhance revenue collection, said UNCTAD.
 
            The Palestinian Ministry of National Economy estimates that the economic cost resulting from occupation, in terms of foregone GDP, was as high as $6.9 billion in 2010, or about 82% of GDP. Had it not suffered this loss, the Palestinian National Authority's fiscal situation would have been sound, and abundant resources for development would have been available.

              UNCTAD cited another study by the World Bank which stressed that re-exporting goods to the Palestinian market had negative effects on the Palestinian treasury and on prices in the Palestinian market.

              According to World Bank estimates, one third of imports from Israel are "indirect imports" of goods produced in a third country. The fiscal leakage resulting from the trade relation was estimated at $133 million annually, equivalent to about 3.2% of GDP, but this also does not include smuggling.

              A Bank of Israel report shows that Palestinian indirect imports through the Israeli commercial sector was at least 58% of the total transactions reported as exports to the Palestinian National Authority from Israel in 2008, or 38% if petroleum and energy exports are excluded.

              The study emphasised that the main cause of fiscal leakage is the nature of the economic relationship resulting from the structure of the Protocol and the clearance system with all its constricting conditions.

              The principal sources of fiscal leakage are as follows:

 (1) Fiscal leakage from the VAT collection system within the framework of the customs union. The transfer of VAT revenues to the Palestinian National Authority is conditional on a clearance bill that is recognized as proof of transaction. However, this mechanism has a number of shortcomings, resulting in sustained losses in Palestinian tax revenues.
  
(2) Leakage from indirect imports. Indirect imports result in the entry of products of non-Israeli origin to the Palestinian market as if they were produced in Israel, or Israeli goods that do not meet the rules of origin to qualify as Israeli exports. Indirect imports are goods imported by an Israeli shipper. Customs duties on them are paid to the Israeli treasury, and they are re-exported to the Palestinian market.

            According to the Paris Protocol, since such goods are perceived to be made in Israel, they enter the Occupied Palestinian Territory duty-free. Since trade taxes constitute a significant part of Palestinian revenues, this results in the loss of access to legitimate fiscal resources by the Palestinian National Authority, but with a number of other serious adverse effects on the Palestinian economy.

             The UNCTAD study underlined that regardless of the manner in which it takes place, indirect imports cause fiscal leakage and much wider economic losses. Depriving the Palestinian National Authority of revenues due to it from this type of importing increases its financial difficulties and limits the scope of fiscal and trade policies at the disposal of decision-makers.

             According to the study, fiscal leakage resulting from importing from the Israeli market (this does not include smuggling) reached an annual average of $115 million in 2010 and 2011, including the foregone VAT, customs duties and purchase tax.

             Average leakage from indirect imports is valued at about $46 million; leakage as a result of the Palestinian National Authority not receiving all its dues from collected purchase taxes and VAT was about $70 million.

             The average annual fiscal leakage resulting from smuggling in 2010 and 2011 (goods smuggled from the Israeli market regardless of its origin) can be estimated at around $190 million.

             One third of this fiscal leakage is due to loss of revenues from import taxes, and the other two thirds are the result of losing revenues of the VAT that could have been collected from these goods.

            The total annual average fiscal leakage resulting from customs duties evasion and direct and indirect importing for the years 2010-2011 is estimated to be around $306 million. This represents around 3.6% of GDP and more than 17% of the tax revenues collected by the Palestinian National Authority in one year. – Third World Network Features.

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

The above is an edited version of an article originally published in the SUNS #7931, 5 December 2014.

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