24. As indicated earlier, 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.
25. Nonetheless, the Palestinian Authority has carried out fiscal measures in the context of the 2008–2011 Palestinian Reform and Development Plan (PRDP). The measures were aimed at improving budget preparation and control processes, integrating the accounting system across line ministries, raising tax rates and the capacity and efficiency of collection, eliminating net lending, instituting a hiring freeze, and improving overall Palestinian Authority financial and procurement procedures. In 2012, the Palestinian Authority raised the top income tax rate from 15–20 per cent, suspending some corporate income tax exemptions, and improving the thoroughness of audits. Consequently, the income tax ratio to GDP rose from 1.4–1.7 per cent between 2011 and 2012, and the VAT rate was increased from 14.5–15 per cent, in line with the change of rate in Israel.
26. In 2012 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 per cent of revenue). As a result, the Palestinian Authority was often unable to pay the salaries of its employees on time and to meet its obligations to creditors. This undermines political confidence in the Palestinian Authority, increases the exposure of the domestic banking system and the private sector and erodes the significant institutional capacity built since the establishment of the Palestinian Authority in 1994. Furthermore, the critical economic situation faced by many households led to popular protests in the West Bank in late 2012 and public calls for abrogation of the Protocol on Economic Relations between Israel and Palestine, known as the Paris Protocol,4 widely deemed to be responsible for the Palestinian economic policy predicament.
27. The same year, lower-than-expected revenue and higher-than-budgeted spending gave rise to a $1.7 billion budget deficit (17 per cent of GDP) on commitment basis; on cash basis, the deficit was 9 per cent of GDP. The difference between the commitment and cash basis reflects the arrears accumulated by the Government during the year. With only $770 million of donor budget support (22 per cent below budget target), the Palestinian Authority had no option but to borrow and accumulate arrears to finance its deficit. In 2012, it borrowed $300 million from domestic banks, raising its debt to $1.4 billion, and it accumulated unpaid wages and arrears of $570 million to the private sector.
28. Public expenditure (commitment basis) was $3.5 billion, 8 per cent above budget, with non-wage current expenditure above the budget target by 16 per cent, while net lending to cover municipalities' utility bills was 270 per cent above the budgeted level (Ministry of Finance, 2013). Development expenditure was a mere $243 million (7 per cent of recurrent expenditure, or 2.4 per cent of GDP).
29. While public revenue rose 1.4 per cent to slightly more than $2 billion in 2012, as a percentage of GDP it declined from 20.9–20.2 per cent. The monetary increase stemmed mainly from a 10 per cent surge of imports, which increased tax revenues cleared by Israel on behalf of the Palestinian Authority by 2.5 per cent to $1.5 billion. However, revenue from sources other than taxes fell slightly, ending the upward trend that had started with the PRDP.
30. 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 (VATs) 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 nonmember observer State by the United Nations in November 2012. This was combined with a unilateral deduction of $121 million to settle outstanding electricity arrears of Palestinian municipalities to Israel Electric Corporation As a result, the Palestinian Authority was able to pay public employees only half of their November salaries by recourse to foreign aid and borrowing from domestic banks (Portland Trust, 2013). As in the past, costly economic disruption was inevitable, although Israel eventually transferred the revenue to the Palestinian Authority.
31. 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 are restricted and sovereignty is denied.