The Palestinian fiscal crisis

On the night before Christmas, the streets of downtown Ramallah were relatively tame. A car drove around the traffic circle at Manara Square with a passenger dressed as Santa Claus leaning halfway out the window ringing a bell. It was quiet aside from the occasional car horn, and most shops were closed by 8:00 p.m.

"Normally, it is more crowded for the holiday," said my taxi driver as we passed through the roundabout. Where are all the people? I asked. "The people?" He chuckled sadly. "The people have no money." 

Indeed, many Palestinians in the West Bank are preoccupied with money these days. Retail prices for gasoline remain among the highest in the world, and prices for basic commodities like wheat, rice, sugar, and fresh meat are consistently 1.7 to 3 times the world average. According to the Palestinian Monetary Authority, which monitors inflation, this is because the Palestinian Territories face higher production and importing costs than most other places. Yet, especially in the case of fuel, government taxes also contribute to high prices. When Prime Minister Salam Fayyad’s government announced price increases on fuel and household cooking gas this fall, it elicited widespread protests and, ultimately, the government was forced to revoke the policy.

Unfortunately, fuel is one of the goods that the West Bank government purchases from Israel. Its price is required by a stipulation in the Paris Protocol, signed between Israel and the Palestinian Liberation Organization (PLO) in 1994, to fall within a 15 percent band of the consumer price in Israel. This, in addition to the Value Added Tax (VAT) levied on all consumer goods, is one area in which the Palestinian Authority (PA) is constrained in setting its tax rates and affecting Palestinian consumer prices. The immediate causes of the PA’s recent fiscal crises have been funding delays and shortfalls (either in tax transfers from Israel, which make up about two-thirds of the PA’s revenue, or in foreign aid). However, a longer-term problem for the emerging state is its inability to fully control the design and enforcement of its own revenue-generating policies. Because a majority of the PA’s operating budget is funded by foreign aid and tax revenue assessed and collected by Israel, the public perceives little connection between taxation on the one hand, and government spending and performance on the other. Further aggravating this situation is the PA’s lack of accountability to a functioning legislature, since the Palestinian Legislative Council has been dormant since 2007. In addition to geographic and ideological fragmentation, one of the many challenges facing the PA — if it is to become the main apparatus of the Palestinian state — is encouraging tax compliance in a context in which it does not fully control the setting or enforcement of its own tax policy nor are domestic actors able to audit how tax revenue is spent. Income tax evasion is reportedly already a problem, even when income-based taxes form such a small percentage of government revenue. Until the Palestinian population is given a greater stake in tax and fiscal policy, the fiscal capacity of state institutions will remain weak.

Perceptions of the PA as a "toothless" bureaucracy affect not only popular compliance with policies, but also incentives to participate in the political process more generally. As an individual in the West Bank, avenues for economic and political participation are available, but the influence of such participation on actual policies seems negligible. For many, there seems to be little that can be done from the bottom up to change this situation. Strikes and protests have become a regular tool for expressing grievances and, as was seen this past fall, sometimes they are effective in forcing the government to reconsider policies.

More recently, PA civil servants have been striking on and off for the past several weeks. Despite the government receiving a $100 million loan from domestic banks to help tide it over, PA workers have still only been paid half of their salaries from November and none of their December 2012 salaries. The crisis stems from the fact that Israel stopped transferring tax revenue it collects on behalf of the Palestinian government in December in response to the Palestinians’ bid for non-member state status at the United Nations. Israel collects approximately 70 percent of the PA’s revenue — about $100 million per month – in customs, VAT, and fuel taxes. Arab League countries have failed to fulfill their pledges of a "safety net" to fill this gap, meaning the PA is operating on about one-third of its traditional stream of revenue. The Fayyad cabinet claims it needs $240 million a month to fulfill its obligations; the bulk of its spending is on wages and salaries. As Ziad Asali and Ghaith al-Omari note, absent action by Israel and the United States, the current financial crisis could lead to the ultimate collapse of PA institutions.

Many employees are struggling to pay for school fees, gas, and bank loans. One ministry employee explained: "You know, when you are broke, you think about everything more. You wonder, ‘should I go into the city [Ramallah] with my family today, or should I save money for gas to go to work in the morning?’" Just recently, the General Transportation Union and unions of taxi and truck drivers have announced that they will continue to strike against taxes, fuel prices, and other fees. These groups were also prominent in the protests earlier this fall. A member of the largest Palestinian union, the General Federation for Trade Unions, told me that a new minimum wage will take effect in January: 1,450 NIS ($384) per month. He described it as an embarrassment: "For this reason, we stand against the current government."

It is expected that governments will become unpopular during times of prolonged economic hardship. However, just as the "Palestinian-as-consumer" faces few choices, the "Palestinian-as-voter" does not face a diverse landscape of options. Local elections were held across much of the West Bank on December 22, 2012 — the second round of the elections that began in October and were set to conclude in November, until the war in Gaza caused them to be postponed. They went ahead without much fanfare. On polling day, I asked a friend whether she would vote. "When I see some gardens or new streets in my neighborhood, then I will vote!" She joked. "Until then, I will not." (Her husband did, however, and followed the returns closely that evening.) About one-half of the 354 municipalities did not hold elections, as lists were running uncontested. Hamas withdrew and did not officially participate in the elections, although candidates affiliated with Hamas ran as independents in some areas.

Continued participation by Palestinians in the formal political process is critical for the consolidation of Palestinian state institutions. Because the Palestinian Authority does not control the assessment and collection of most of its revenue, the fiscal capacity of the government is seriously constrained, and this affects the perceived impact by the population of voting and other forms of institutionalized participation. It is no surprise, then, that strikes and public protest have become the weapons of choice for West Bank residents.

Without endowing the Palestinian Authority with more control over its own revenue-generating policies and forcing it to report on its spending to a domestic assembly, it will be difficult to sustain public engagement in the political process when the potential for policy influence remains so remote. International actors should encourage such a change, insisting that it is accompanied by an expansion of the PA’s geographic jurisdiction and, therefore, its ability to reach the Palestinian population with broad-based services. (The PA is severely limited in reaching people in Areas B and C of the West Bank, Palestinian ID holders in the "seam zone" on the Israeli side of the wall, and residents of neighborhoods surrounding Jerusalem who have been virtually cutoff from many services inside the city.) 

If the status quo remains, the PA may still improve its capacity in certain areas of fiscal management such as managing foreign aid and general expenditure. However, the government will still struggle to improve its popular legitimacy if it cannot effectively justify its tax policy in terms of direct benefits to the population. As such, compelling payment and encouraging a culture of tax compliance is going to be particularly difficult when Palestinians have become accustomed to seeing tax revenue used strategically by Israel to punish or reward the Palestinian government as it sees fit. Instead of the PA benefiting from a stable domestic tax base, protest and non-compliance have become regular features of the bargaining process between the cash-strapped government and its frustrated population.

Diana Greenwald is a doctoral student in the Department of Political Science at the University of Michigan-Ann Arbor. Her research focuses on government strategies of revenue production in new and aspiring states. Her recent research was funded in part by a grant from the Project on Middle East Political Science. Follow her on Twitter: @hispeedtourist.