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World Bank Warns Of Palestinian Fiscal Crisis

by Lorys Charalambous,, Cyprus

25 September 2012

The Palestine Authority (PA) will require some USD400m in additional international aid to balance its books after the nation's efforts to boost tax revenues failed during the first half of the year, the World Bank has said.

The World Bank's latest report reveals that the PA undershot its budget deficit target by 32%. Expenditure increased by 4.5% while total revenues were 7% below targets, resulting in a deficit of NIS2.4bn (USD632m). Due to a significant fall off in international aid, the PA had to incur additional arrears amounting to NIS1.1bn during the first half of 2012, 42% of which is owed to the private sector, and the World Bank has warned that the government is no longer in a position to lean on local banks for financial support.

Gross domestic revenues totalled NIS1.4bn, 10% lower than projected in the budget, having risen by 1% despite numerous measures designed to boost receipts. The budget had targeted revenue growth of 17%, but fell considerably short despite a 45% increase in income tax collections, a 6% increase in property tax receipts, and unchanged collections from the value-added tax (VAT).

A number of reforms have been undertaken by the PA to close the budget gap including tax base broadening, and the chasing of tax arrears and liabilities from the largest corporations. Personal income tax rates were substantially hiked, and authorities reached an agreement with fifteen private sector companies to voluntarily give up all tax exemption privileges granted by the Palestinian investment promotion law for a period of two years.

Despite all these efforts, the PA reported that tax revenues will not be able to reach their projected end-of-year target. Meanwhile non-tax receipts were 12% lower than their half-year budget target and 8% lower than in the first six months of 2011.

Clearance revenues, from trade, were reported to have performed well throughout the first half of 2012 despite not meeting their optimistic budget target. They totalled NIS2.8bn, 6% below their budget target but 13% higher than the same period last year.

The World Bank said that this growth in clearance revenues is a significant achievement for the PA, which has been making strong efforts to reduce leakage in the VAT and import duties collection process.

The World Bank in particular lauded the signing of an agreement between Israel, which collects the clearance revenues, and the PA on July 31, 2012. The pact aims to streamline procedures and boost trade. A report from the United Nations in February noted that a major source of Palestinian fiscal instability is rooted in the Israeli control of the tax and customs clearance revenue it collects on behalf of the PA, which accounts for 60% to 70% of total Palestinian revenue. It highlighted that had the Palestinian Authority also collected taxes on so-called “indirect imports” — goods not labelled as destined for the Palestinian Authority and imported and resold by Israel in the Palestinian Territory — clearance revenue could have increased by USD500m. This figure is equal to more than 8% of the PA's gross domestic product and 25% of public revenue.

Under the latest agreement, the Israeli Customs Authority will start sharing real time data on direct imports to the Palestinian territories, as well as information on VAT receipts issued by Israeli traders to Palestinian importers. In addition, advanced technologies will be employed to facilitate and monitor trade between the two parties, and special bonded warehouses will be established on the Palestinian side to allow Palestinian Customs to assume responsibility on the clearance of direct imports to the PA from third countries. The World Bank said: "Such measures could substantially reduce tax leakage and increase clearance revenues. Thus, it is hoped that both parties will implement the agreement starting 2013, as planned."

The World Bank highlighted that to achieve sustainable finances in the medium-term, significant efforts need to be taken both by PA authorities on fiscal policy, and by international agencies and governments to resolve the territorial dispute between Israel and the PA.

The World Bank highlighted the importance of the return of Area C of the West Bank to Palestine, as agreed under the Oslo Accords. The area holds significant natural resources, and is vital for national linkages. Under the Accords, the mainly open areas of Area C were to be handed over to the Palestinians by 1999 but this has not been done.

The World Bank noted that Palestinian enterprises that do manage to locate in Area C tend to avoid paying taxes to the PA. Because the PA cannot exercise authority in Area C, it is unable to enforce laws or regulate businesses there. Consequently, Palestinian businesses located in Area C are able to conduct their operations without paying taxes, fees or meeting health and safety standards. The only recourse for the PA is to attempt to intercept products being brought into Areas A and B, where it can deploy its own enforcement. Consequently the PA loses tax revenues from small enterprises operating in Area C.

The World Bank noted: "Palestinian access to Area C of the West Bank is a key to unlocking some of this private sector opportunity. This 60% of the West Bank, which remains under full Israeli control, holds most of the agricultural lands, natural resources, and land reserves of the West Bank. Putting these resources to work can provide an economic foundation for growth in important sectors of the economy. Access to Area C has the potential to play a central role in the development of businesses such as construction, telecommunications, agriculture, and tourism."

Further measures could be introduced to improve tax collections, according to the World Bank, which recommended that, "a medium-term agenda should concentrate on strengthening revenue administration and broadening the tax base. In the area of tax administration, the focus should be on integrating the administration of value-added tax and income tax and implementing self-assessment as advised by the International Monetary Fund."

TAGS: tax | economics | business | fiscal policy | law | budget | Israel | West Bank | trade

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