Info Service on WTO and Trade Issues (Dec14/02)
9 December 2014
Third World Network
losing $306 million a year in fiscal leakage to Israel
Published in SUNS #7931 dated 5 December 2014
Geneva, 4 Dec (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)
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 per cent of total tax revenue, in addition to 4 per cent 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
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
These stem mainly from the fact that the Protocol is outdated and
related to a transitional period that was supposed to end in 1999,
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
According to the study, the analysis shows that fiscal leakage from
the aforementioned sources exceeded $310 million in 2011, equivalent
to 3.6 per cent of total gross domestic product (GDP) and 18 per cent
of the tax revenue of the Palestinian National Authority.
Around 40 per cent of the fiscal leakage is related to direct and
indirect imports from Israel, and the remaining 60 per cent 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 per cent 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 per cent 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
According to the study, total indirect taxes amount to over 85 per
cent 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 per cent 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 per cent
between 1999 and 2011 to reach 12.4 per cent 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 per cent 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 per
cent 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 per cent of
Another key element of the Palestinian fiscal crisis is the extremely
low development expenditure, which was only $215 million (or 3.4 per
cent of GDP) in 2008.
Expenditures on development expanded slightly in 2011 to reach $368
million, or 4.2 per cent 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 per cent 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
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 per cent 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 per cent of the total
transactions reported as exports to the Palestinian National Authority
from Israel in 2008, or 38 per cent if petroleum and energy exports
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.
These losses were mainly the result of smuggling and tax evasion,
* Non-submission of clearance bills to the Palestinian tax offices.
This is motivated by withholding information and tax evasion whereby
VAT on invoices from purchases from Israel is paid to the Israeli
merchant who in turn pays it to the Israeli treasury, and revenues
are not transferred to the Palestinian treasury through clearance.
The Ministry of Finance estimates the cost of VAT evasion at around
However, said the study, the Ministry of Finance estimates are well
below those of the IMF, which indicates that the proportion of Palestinian
bills not submitted ranges between 30 and 70 per cent.
* Forgery and manipulation of clearance bills. As indicated by staff
from the Palestinian Ministry of Finance, this includes printing fraudulent
clearance bills that are not acknowledged by the Government. These
bills are then used between merchants and they cannot be submitted
at the clearance sessions.
Clearance bills of fake transactions are sold to an Israeli counterpart
in return for a percentage that varies between 3 and 7 per cent in
order to deduct the value of items listed in the fake transaction
bills from the VAT.
Therefore, the Israeli merchant who buys the bill benefits because
the deduction becomes large, and the merchant benefits by obtaining
cash without any actual transaction having taken place.
The Palestinian treasury loses part of the VAT because Israel does
not pay the tax of those bills to the Palestinian National Authority.
The Palestinian National Authority losses are in the range of about
$7 million annually from this type of manipulation.
* Tax and evasion of customs duties. This entails the movement of
goods from the Israeli market and settlements to the Palestinian market
without any documentation, which results in purchase tax and VAT losses.
Officials and experts from the Ministry of Finance estimate that more
than 30 per cent of goods enter the Palestinian market without clearance
bills, since the borders between the West Bank and Israel are porous,
and trade between the two sides is carried out under the terms of
the customs union.
(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
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
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
per cent of GDP and more than 17 per cent of the tax revenues collected
by the Palestinian National Authority in one year.
To evaluate the costs of the fiscal leakage, the study said the macro-econometric
model developed by UNCTAD of the Palestinian economy was simulated
to assess economic performance under alternative scenarios that assume
that the leakage did not occur and the leaked resources were instead
available to the Palestinian National Authority to finance, for example,
either transfer payments to the poorest or an export promotion programme.
Three alternative scenarios were simulated:
* The baseline scenario reflects economic performance under the present
conditions using actual historical data, including fiscal leakage;
* The transfer payment scenario also uses historical data, but assumes
no fiscal leakage and hence an increase in tax revenue (17 per cent)
equivalent to the estimated leakage, which is used to increase expenditure
on transfer payments;
* The export promotion scenario is similar to the second scenario,
but assumes that the increase in revenue is allocated to promote Palestinian
According to the study, results show that capturing the leaked revenue
would expand the fiscal policy space available to Palestinian policymakers
and facilitate fiscal stimulus.
While the transfer scenario would increase real GDP in 2004 dollars
by about $205 million (3 per cent) above the baseline in 2012, the
export promotion scenario would increase GDP by $280 million (4 per
As for the impact on employment, the transfer and export promotion
scenarios would increase employment over the baseline scenario by
3,300 and 9,200 jobs respectively.
The estimated costs to the Occupied Palestinian Territory of the $306
million leaked annually to Israel is equivalent to 17 per cent of
total tax revenue, in addition to 4 per cent in lost GDP and about
10,000 jobs per year. The analysis also shows that these costs are
compounded over time as the economy grows.
UNCTAD however cautioned that the estimated fiscal leakage in this
study is modest and conservative, given that the research did not
take into account total accumulating economic losses resulting from
many other channels of fiscal leakage that are not covered by this
Second, said the study, it would be necessary to carry out additional
studies covering all sources of Palestinian fiscal leakage.
Third, the economic cost of the estimated fiscal leakage in this study
is modest, considering the structural deformity of the Palestinian
economy and its limited capacity to create highly productive job opportunities
because of restrictive policies under prolonged occupation and the
forced erosion of the Palestinian productive base.
"As a result, the economy is forced to increase imports when
new fiscal and/or economic resources are available."
The study said that there is an urgent need to make fundamental changes
in the structure of the Palestinian trade system under the Paris Protocol.
"This system, which has endured for two decades, has not allowed
the Palestinian economy to achieve tangible or sustainable development;
it has actually prevented such development. This is mainly due to
Israel's lack of commitment in applying the terms of the Protocol,
as well as the shortcomings of some provisions relating to trade,
taxation and monetary policies."
The study suggests a number of recommendations pointing to the pressing
need to change the modus operandi of the Palestinian import regime
to ensure Palestinian rights in all economic, trade, financial and
This will require new trade arrangements that cover borders, customs
and a tax collection mechanism to prevent fiscal leakage to Israel.
With regard to indirect imports, information should be exchanged regularly
between the Palestinian and Israeli authorities, customs and monitoring
systems should be developed and the Government of Israel should acknowledge
Palestinian financial entitlements to purchase taxes on goods made
in Israel and sold on the Palestinian market and to the customs duties
and purchase tax revenue collected on products indirectly imported
through Israel, said the study. +