In the absence of a national currency, fiscal policy is the main policy instrument available for macroeconomic management in the West Bank and Gaza Strip. Consequently, the soundness of fiscal policies has far-reaching implications for achieving a high level of sustainable economic growth. In addition to its impact on aggregate demand, the composition of government expenditures and the efficiency of the tax system will affect total factor productivity in the economy and private sector investment and growth in particular.

In the absence of a national currency, fiscal policy is the main policy instrument available for macroeconomic management in the West Bank and Gaza Strip. Consequently, the soundness of fiscal policies has far-reaching implications for achieving a high level of sustainable economic growth. In addition to its impact on aggregate demand, the composition of government expenditures and the efficiency of the tax system will affect total factor productivity in the economy and private sector investment and growth in particular.

Since its establishment in 1994 the Palestinian Authority has made considerable progress in establishing a fiscal administration and in financing recurrent expenditures from its own revenues. Indeed, in 1998 a small recurrent surplus is budgeted compared with a deficit of $96 million in 1996. Revenues, in particular, have risen sharply as a result of improvements in tax administration. Following the sharp increase in recurrent expenditures in 1994-97, the early years of forming the Palestinian Authority administration, the growth of recurrent expenditures is expected to level off in 1998, aided in particular by a restrictive recruitment and wage policy. Despite efforts to stabilize the fiscal position, however, the overdraft and arrears of the Palestinian Authority have been increasing due to the diversion of some revenues to accounts outside the control of the Ministry of Finance.

In parallel with the improvement in the fiscal position, there is an increasing recognition within the Palestinian Authority that fiscal policy needs to be used to lay the ground for private sector growth, especially under the difficult conditions of border closures that have been outlined in Chapter 3. Thus, this chapter will concentrate on two areas in which the fiscal policy of the Palestinian Authority can have the strongest impact on private sector activity in the West Bank and Gaza Strip: the tax system and the expenditure policy of the Palestinian Authority.

The Tax System

A good market-based tax system must balance efficiency, equity, and simplicity in a way that raises adequate revenue for financing an appropriate level of government expenditures while promoting a high level of private sector investment. At the same time, with increased capital mobility and globalization, a sound tax system must also remain competitive vis-à-vis those in neighboring countries. In the case of the West Bank and Gaza Strip, the Protocol on Economic Relations with Israel has placed some restrictions on the design of the tax system. Nevertheless, the scope for improving the tax system in support of private sector activity remains considerable.

Existing Constraints and Reform Priority

Under the Protocol on Economic Relations, the major trade and purchase taxes in the West Bank and Gaza Strip cannot be modified significantly. Indeed, the Protocol also limits any permissible deviation of the value added tax (VAT) rate in the West Bank and Gaza Strip to no more than 2 percentage points below that of Israel. However, the Protocol provides for unilateral changes in the West Bank and Gaza Strip income tax laws (individual and corporate) and in a small number of customs duties on certain goods.

The fact that tax reform must be confined to direct taxes is not too limiting because the indirect tax system is relatively well designed. In contrast, the income tax is dated and inefficient. Thus, in the short term, the priority should be to make the income tax more efficient and supportive of growth.

Current Income Tax System

The current income tax is in need of fundamental overhall.1 Partly a vestige of history and partly a result of years of general neglect, the income tax is outdated, costly to administer, and imposes high compliance costs on taxpayers. In addition, the system is not uniform. In the West Bank, for example, the legal base for the income tax is rooted in the Hashemite Kingdom of Jordan Income Tax Law No. 25 of 1964 (as amended), while in the Gaza Strip the legal base originates from the British Mandate Income Tax Ordinance No. 13 of 1947 (as amended). While the tax in the West Bank is based on the territorial principle, that in the Gaza Strip is based on the residence principle. The corporate tax rates are also not uniform—38.5 percent in the West Bank and 37.5 percent in the Gaza Strip—and are high by regional and international standards. In addition, all agricultural incomes in the West Bank are free from tax while similar incomes are taxed in the Gaza Strip.

Other weaknesses in the present income tax include a complex and inadequate system of depreciation allowance for capital investments, the lack of clear rules for inventory valuation, and restrictive carrying forward of losses. At the same time, tax exemptions are widespread. For example, under the current investment promotion code, income tax holidays ranging from 2-5 years are available depending on a project’s paid-up capital,2 on the number of permanent Palestinian workers employed,3 and on its duration. Further-more, wide unspecified discretionary power to grant additional and exceptional exemptions to large projects, defined as exceeding $5 million in paid-up capital and employing at least 50 permanent Palestinian workers, is also present.

On the personal income tax, deductions are prevalent. For example, standard deductions for self, spouse, children, and parents are generous while nonstandard ones such as wage/salary, education, and medical deductions are distortive. In particular, because the wage/salary deduction at the personal level is treated as an expense at the company level, a well-defined stream of income is effectively not taxed. In addition, the personal income tax has too many brackets, and marginal rates are steeply progressive reaching 48 percent for income above $49,000.

The weak income tax law, coupled with a nascent tax administration, has undermined revenue collection from personal incomes and business profits. Income tax revenues are relatively insignificant, amounting to only 10 percent of total revenue in 1997. However, the low yield presents an opportunity for revamping the income tax without major risks to the budget. Indeed, a modern income tax law can partially compensate for some other disadvantages faced by the Palestinian private sector. In this regard, a new draft income tax law and investment promotion code will be presented to the Legislative Council soon.

A Competitive Income Tax System

A tax system that is designed to encourage private sector activity and to attract capital investment must be business-friendly and competitive, while avoiding the use of cost-ineffective incentives. Such a system should contain the following general characteristics.4

First, the corporate tax should have a low rate that is set at, or at about, the same rate as the lowest corporate tax rate in the region. Therefore, the corporate tax in the West Bank and Gaza Strip should be set at a unified rate, preferably at 25 percent for all sectors of the economy, including the financial sector.

Second, a generous and simple system of depreciation charges should be a prominent feature. For administrative simplicity, the Palestinian Authority should adopt a simple system of pool account depreciation where there are no more than 4—5 asset groups. A declining balance approach should be used as it allows for the pooling of all assets with the same depreciation rate in one group for which the only record of relevance would be the undepreciated balance.

Third, a system of well-targeted investment tax credits should be introduced in lien of current tax holidays if it is politically infeasible to withdraw completely all incentives. This would limit revenue losses to the ceiling offered by the tax credits. However, all holidays that have already been provided should be honored.

Fourth, generous personal income tax deductions (as noted above) that are poorly targeted should be eliminated in favor of personal tax credits. This should improve tax equity while providing maximum flexibility for the reduction in tax rates. The top individual income tax rate should also be set at the same level as, or be as close as possible to, the corporate tax rate.

Last, but not least, any discordant parts of the tax systems in the West Bank and in the Gaza Strip should be removed.

Expenditure Policy

An appropriate expenditure policy can support macroeconomic stability, promote equity, and enhance growth. Concerning its impact on growth, public spending has two opposing characteristics. On the one hand, public expenditures that need to be locally financed may crowd out private investment and reduce private sector activity. On the other hand, some spending programs will complement private sector activity and, over time, increase its productivity in the West Bank and Gaza Strip. Government spending should center on health and education to enhance human capital accumulation, and on public investment in basic infrastructure to support a buildup of non-military capital stock.5 These areas are the focus of discussion in the remainder of this section.

Budget Allocation for Health and Education

The analysis below suggests that substantial increases in real terms in spending on health and education will be required to maintain the present high level of services in these areas.6 If these requirements are not to put excessive pressure on the fiscal position over the medium term, the Palestinian Authority will need to resort to increased cost sharing and private sector participation, as well as strict prioritization in these sectors.


The Palestinian health system consists of four service providers: the Palestinian Authority, UNRWA (for those in refugee camps), nongovernment organizations (NGOs), and the private sector.7 While complex, this integrated health care system has so far produced an admirable standard of health care service compared to other countries with a similar level of economic development. In some instances, it approaches those of newly industrialized Asian countries. For example, life expectancy in the West Bank and Gaza Strip at 71.7 years is much higher than that of several Middle East and North Africa (MENA) countries such as Egypt, Jordan, and Tunisia, and it is comparable to South Korea (72 years), but lower than Israel (77 years) (see Table 1). Infant mortality at 28 per 1,000 is much lower than that of the MENA countries, although it is more than twice as high as that of South Korea, and more than thrice that of Israel. In addition, malnutrition is rare. Equally important, access to primary and secondary level health care services is generally adequate and affordable even for the poor, although tertiary health services are more scarce. However, of some concern is the high fertility in the West Bank and Gaza Strip, which at 6.2 is the highest in the region and more than three times that of South Korea (1.8).

Table 1.

Basic Health Indicators

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Sorces: Palestinian Central Bureau of Statistics: and World Bank.

While health care services are generally adequate for now, the pressure to maintain current standards is enormous owing to several factors. On the demand side, the high rate of population growth in recent years (estimated at 4.5 percent in 1996) will give rise to unprecedented demand for health care services in the near future. On the supply side, the gradual but steady cutback in recent years of NGO-provided health care services (resulting from reduced funding to such organizations because of a diversion of international financial assistance away from NGOs to the Palestinian Authority) has reduced access to basic care in the health care system for many poor Palestinians. In addition, the eventual withdrawal of UNRWA health care services to the refugee population in the near future could further reduce the supply of health services in the West Bank and Gaza Strip and impose further demands on Palestinian Authority-provided health care.

Successfully meeting the demands for quality health care services in a financially viable way requires the Palestinian Authority to adjust its current health care priority, as well as taking measures to address the health-care-related financial burden on its budget. In addition, to strengthen the health care system, the Palestinian Authority should also encourage further private sector participation, particularly at the tertiary care level in order to enhance the present integration of public and private care.


To control escalating costs that can be expected to accompany a higher level of demand, the Palestinian Authority needs to prioritize its health care expenditures. As basic care is instrumental in providing a growing child with the minimal level of care that ensures its proper development, a health care system that emphasizes adequate primary care will in the long term be more cost-effective than one that allocates its resources mainly to secondary and tertiary care. In fact, the relatively good health indicators in the West Bank and Gaza Strip today are a reflection of a sound system of health care that in the past has stressed basic care.

In the near future, the Palestinian Authority will need to devote more resources to basic health care services. This is because of two recent developments. First, as noted, NGO-provided primary care has been curtailed, resulting in a diminished level of care generally as well as reduced access in remote areas. Second, in recent years, the Palestinian Authority has increasingly devoted a fairly significant share of its health resources to two areas that are outside the ambit of basic care, namely, hospital care8 and increasing hospital capacity.9 The combined effect of these developments has shifted the emphasis from basic care to tertiary care. In particular, it is vital that the high level of access to primary care of the recent past is maintained and greater attention be paid to remote villages in view of the sharp reduction of services in those areas. To ensure the adequacy of tertiary care as resources of the Palestinian Authority are shifted toward basic care, the Palestinian Authority should make greater private sector provision in tertiary-level care one of its main health care policy goals (see below).


Because providing a quality care service in the face of rapidly increasing demand will impose a high financial burden on the Palestinian Authority, new sources of financing health care must be explored. This challenge can be met by increased cofinancing. The policy options for achieving this are the reform of the Palestinian Authority health insurance system and the expansion of cost recovery programs.

In 1996, general tax revenues provided financing for more than 60 percent of the Ministry of Health budget while health insurance contributions accounted for about a quarter, and user fees, the remainder.10 While existing direct contributions (health insurance premiums) and user fees may already be burdensome to the poor, they are relatively low in comparison to the level of benefits that are offered. For example, on direct contributions, government employees pay only 5 percent of their basic salary per month, up to a maximum of $20, to enroll in the health insurance system while nongovernment employees who choose to join the health insurance system pay approximately $11 per month for a single individual or $20 for a nuclear family, regardless of size.

For those insured, outpatient visits to a Palestinian Authority clinic or hospital cost approximately a token $1 for each item of medication prescribed regardless of the type of treatment received. Inpatient visits to Palestinian Authority hospitals are free. For those without health insurance, fees for outpatient visits are only somewhat higher (according to a less heavily subsidized cost schedule depending on treatment) while inpatient visits may be charged up to $200 per day for intensive care. For both insured and uninsured, referral services costing up to about $6,500 to non-Palestinian Authority hospitals are also available. However, because referrals are expensive to the Palestinian Authority, access is controlled. In addition, all treatment for children below the age of 3 is free.11

This pricing system is inefficient. For those insured, not only does it not discriminate against the type of care provided for outpatient services, it also does not create the right incentives for inpatient visits by allowing free admission. For the uninsured, the price of outpatient treatments, which are heavily subsidized (although less so compared to those insured), also provide no incentive for them to join the health insurance system. Thus, the pricing structure is in need of reform to allow a more efficient allocation of medical services.

With current low insurance premiums and user fees, the expected increase in demand for health services in the near future will exert a disproportionally high burden on the budget. This is because the share of cost recovery (premiums and fees) in the overall funding of the Ministry of Health budget can be expected to fall with increased demand if no adjustments are made to the present system. Thus, to reduce or slow the Increase of this burden on the Palestinian Authority budget, the system of financing health care needs to be modified. In fact, the combined funding from health insurance premiums and user fees in 1996, at less than 40 percent of the Ministry of Health budget, is low compared to more than 60 percent in the past (in part, a result of a recent Palestinian Authority decision to lower the insurance contribution premiums).

A target to raise this level to 60-65 percent of the Ministry of Health budget in the medium term may be appropriate, as this was the range of the pre-1994 funding level. This can be achieved by reducing the general level of implicit subsidy by increasing and broadening the coverage of insurance premiums and by increasing user fees for both outpatient and inpatient visitations. In addition to recovering costs in the short term, these adjustments should also improve the pricing structure of medical services, which should provide the proper incentives to users, thus, assisting the Ministry of Health to control costs in the long term. To ensure that the poor are not denied access to a minimum level of health care as a result of these rate adjustments, the Palestinian Authority could consider introducing a system of targeting for the poor.

Private Sector Participation

To supplement its provision and enhance the current mix of Palestinian Authority and non-Palestinian Authority providers, the Palestinian Authority should encourage private sector participation at all levels of health care services and, particularly, in tertiary care services involving expensive advanced medical technology. This strategy should be developed in line with the objective to reduce the high reliance on hospitals outside the West Bank and Gaza Strip, which are very costly. For example, in 1996, the cost of overseas treatment of admitting Palestinian patients to hospitals in Israel, Jordan, and Egypt amounted to slightly less than 20 percent of the Ministry of Health budget.12 With more local private hospitals, and the newly established European and Japanese hospitals, considerable cost saving can be expected from not sending Palestinians to overseas hospitals, thus freeing some of the Ministry of Health health resources that would have been allocated for overseas treatment.

The potential for attracting greater private sector participation in providing quality care appears good. The recent strong interest in forming large Palestinian-owned private health care companies that is supported by many well-trained physicians is indicative that a viable private sector care industry can develop in the West Bank and Gaza Strip.


Like the health sector, joint provision is a hallmark of the education system in the West Bank and Gaza Strip, with the Palestinian Authority, UNRWA, and the private sector, including NGOs, providing complementary schooling from basic to university education.13 The Ministry of Education has overall responsibility for basic and secondary schools and the Ministry of Higher Education is responsible for the development of higher education, which is financed mostly by non-Palestinian Authority entities.

The Palestinian Authority dominates the provision of schooling for children between the ages of 6–17, operating up to 70 percent of all basic schools (for 6–12 years old in primary schools and for 13–14 years old in preparatory schools) and up to 85 percent of all secondary schooling (for those in the 15–17 years age group). UNRWA complements the Palestinian Authority by concentrating its efforts on the schooling of children in refugee camps up to the basic level. It funds and administers about a quarter of all basic schools in the West Bank and Gaza Strip and a small number of preschools for toddlers below the age of 6. Strongly reinforcing UNRWA’s efforts in the schooling of younger children, the private sector, including NGOs, operates up to 95 percent of all preschools. At the same time, the private sector, supported by the European Union (EU), is the sole provider of university-level education, funding all eight universities, as well as running a small, but significant, number of basic schools (5 percent) and secondary schools (15 percent).

Despite the diversity in provision, the coverage and quality of the school system in the West Bank and Gaza Strip is relatively good, although there is still much room for improvement. In general, the population and the labor force are fairly well-educated by regional standards. Social indicators in education for the West Bank and Gaza Strip compare favorably against those of its neighbors. For example, the literacy rate for those in the 15–19 age group is 97 percent in the West Bank and Gaza Strip, which is comparable to Israel and much higher than that of the MENA region (79 percent) (see Table 2). For those above 15 years of age, the literacy rate is 84 percent relative to a rate of 57 percent in the neighboring countries. In addition, school enrollments in primary and preparatory schools in the West Bank and Gaza Strip for both males and females are high (more than 90 percent), while those in secondary schools are moderately high (less than 70 percent).

Table 2.

Comparative Educational Attainment Indicators

(In percent)

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Sources: Palestinian Central Bureau of Statistics; and World Bank.

These indicators have been translated into a relatively well-educated workforce that should bode well for the Palestinian economy as it begins to participate more fully and compete more actively in the regional and world markets. To ensure that this level of advantage over its neighbors is maintained over the long term, the Palestinian Authority should continue to stress the importance of education. In particular, it should improve the current level of access up to the secondary level and enhance the quality of its education services.

New Challenges

While the need to improve the education system is always present, the ability of the Palestinian Authority to maintain even the current standards will come under mounting pressure. Three largely unrelated factors emerge as being particularly significant. First, the high fertility rate, which has averaged more than 6 percent in recent years, will soon place a very high demand on the Palestinian Authority to absorb the growing number of children into the system. This would call for devoting substantially more resources to building new schools and for training and employing a large number of new teachers, as well as increasing the supply of teaching materials. Second, following years of general neglect in school maintenance under the Israeli Civil Administration, many existing schools are now in need of major repairs. Third, the eventual withdrawal of UNRWA’s support for basic education in the near future will place an additional significant burden on the Palestinian Authority.

In the presence of these emerging pressures, a broad strategy for managing the education system must become one of the highest priorities for the Palestinian Authority in order to preserve its standing in education in the region and to promote a high level of learning in its future workforce. The Palestinian Authority needs to set long-term educational objectives covering developmental plans, governance, finance, and management.

Maintaining High Access to Primary and Secondary Education

More schools will have to be built and old schools rehabilitated. It has been estimated that over the period 1995 to 2025, all else equal, the number of spaces in basic schools must be increased by 95 percent, in preparatory schools by 115 percent, and in secondary schools by 125 percent, in order to meet the needs of the rapidly growing population in the West Bank and Gaza Strip.14

If a doubling of the student population translates into a doubling of schools, then the number of schools will need to be doubled to 2,700 in the education system by the year 2020. From today to the year 2000, 330 more primary schools would have to be built. At the same time, as school maintenance was given a low priority in the past, many schools are now in need of urgent major repair work. All these factors imply that the investment budget for schools will have to be increased considerably over the next few years. To the extent that donors are willing to continue funding the building and rehabilitation of schools, the financial pressure on the Palestinian Authority will be greatly reduced. If not, the Palestinian Authority would have to explore new ways of paying for an increasing number of schools (see below).

In parallel with the rehabilitation of run-down schools and building of new schools, school facilities should also be used intensively. While three-shift schools should be changed to double-shift ones, moving to universal single-shift schools does not appear appropriate because it would greatly increase the demand for resources for more schools. Although double-shift schools may be less conducive for learning for some students, a system of single-shift schools should not be a high priority for the Palestinian Authority at this moment. In fact, many Asian countries with higher income levels still adopt a double-shift school system because of the high cost of single-shift schools.

A large number of quality teachers will need to be employed to meet the rising demand for basic and secondary education of a growing population. Assuming that the current teacher to student ratio of 1:46 is maintained, the number of teachers will need to be increased from about 16,500 in 1996 to 33,000 in 2020.15

Encouraging Diversity in the Provision of Education Services

The Palestinian Authority should strive to maintain a mix of providers of schools. Diversity in the provision of education encourages competition and strengthens the education system. Thus, the present mix of private and public schools up to the secondary level should be preserved. While to a lesser extent this principle may also be extended to university education, numerous competing demands for limited Palestinian Authority resources at the moment suggest that the provision of university education in the West Bank and Gaza Strip is best left to the NGOs, which have been the traditional source of funding for university education, and the private sector.

However, in view of recent developments concerning the funding for universities, the Palestinian Authority would need to formulate new financing options for higher education. The EU has recently expressed its intention of cutting direct funding to universities in the West Bank and Gaza Strip. In the absence of other donors stepping in to fill the gap, the most likely short-term impact would be a higher burden on the Palestinian Authority, while in the longer term, competition at the university level may be reduced if the Palestinian Authority financed all universities. Neither of these outcomes is desirable. Thus, in anticipation of the eventual withdrawal of funding by the EU, the Palestinian Authority should begin to invite other international NGOs and well-endowed Arab institutions to accept the funding responsibility for universities in the West Bank and Gaza Strip.

The option of replacing donors’ funding with Palestinian Authority budgetary sources should be avoided, except possibly for a temporary period. Accepting funding responsibility for universities will most likely involve a trade-off such as curtailing or postponing other education projects at the more basic schooling level. This is not recommended, as the social rate of return on higher education while positive is not as high as that of lower levels of education.16

In addition, regional experience has shown that public funding of higher education may be extremely inefficient in the long run. In the face of high youth unemployment, students are admitted to publicly funded universities to provide a one-shot respite for the authority grappling with high youth unemployment. To make matters worse, some countries have also guaranteed government jobs to university students on graduation, resulting in a bloated civil service. In the event the Palestinian Authority is left with no option but to fund higher education, it should ensure that its financing role is kept limited. To achieve this, it should introduce fees to maximize cost recovery.

Physical Infrastructure

In addition to investment in social infrastructure, adequate public investment in physical infrastructure is also important for promoting growth. Indeed, several empirical studies have found strong correlation between private sector productivity and spending on nonmilitary public capital stock.17

The West Bank and Gaza Strip suffers from a deficient and unreliable infrastructure owing to years of neglect and under investment. Large parts of the infrastructure stock are unused because of system losses or disrepair. Virtually all the major roads were constructed before 1967 and received minimal or no maintenance. In the early 1990s, the West Bank and Gaza Strip had only 80 meters of paved roads per 100 people compared with 170 meters in Jordan and 266 meters in Israel.18 International transportation (ports and airports) was almost entirely under Israeli control. Moreover, even though the bulk of West Bank and Gaza Strip households had electricity connections, such connections did not necessarily denote adequate or steady supply of electricity Indeed, electricity supply was estimated to be 13 kilowatts per 100 people in the West Bank and Gaza Strip while it was 25 kilowatts in Jordan and 82 kilowatts in Israel. Electric power system losses in the West Bank and Gaza Strip were 30 percent, while in Jordan they were 19 percent and in Israel they were only 4 percent. Another severe impediment to growth was restricted access to telecommunications, though this is being partially overcome through the mobile telephone network. Furthermore, although more than 90 percent of West Bank and Gaza Strip households were connected to the water supply, water consumption per head in the West Bank and Gaza Strip was less than 90 liters per day, compared to 140 liters in Jordan and 280 liters in Israel. Also, water quality in the West Bank and Gaza Strip was steadily deteriorating. Of even greater concern, only about 25 percent of West Bank and Gaza Strip households were connected to sewage networks, compared to 100 percent in both Jordan and Israel and 50 percent in Egypt. Sewage collection, treatment, and disposal were growing, major problems.

Recognizing these deficiencies in the infrastructure, during 1994—September 1997 donors committed to the West Bank and Gaza Strip almost $3 billion in assistance, out of which $1.1 billion was, in descending order of magnitudes, for investment projects in eight social and physical infrastructure sectors: water and sanitation, multiple sectors, education, housing, transportation, health, energy, and solid waste (Table 3).19 Commitment for physical infrastructure sectors (i.e., excluding education, health, and housing) amounted to $754 million. At the first Consultative Group meeting for the West Bank and Gaza Strip in December 1993 it was agreed that the public investment program was to emphasize infrastructure and human resource development. The focus of the program was initially on upgrading, repairing, and maintaining existing facilities, as well as gradually undertaking new construction. Human resource development aimed to maintain essential services, while initiating institutional, policy, and structural reforms. This orientation remained to a large extent intact at the subsequent donor meetings.

Table 3.

West Bank and Gaza Strip: Public Investment Projects by Sectors, 1994-97:Q11

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Source: MOPIC, MOPIC’S 1997 Third Quarterly Monitoring Report of Donor Assistance. November 23, 1997.

Disbursements for public investment projects and, in particular, infrastructure, were significantly less than envisaged, however. Out of the $1.8 billion disbursed by donors during 1994-September 1997, only $544 million was for public investment projects in the eight sectors cited above, with those for physical infrastructure amounting to only $355 million. Multiple sectors received the largest amount of investment, followed by water and sanitation, housing, education, health, transportation, solid waste, and energy. The disbursement ratios (disbursements relative to commitments) for these sectors varied widely. In particular, housing had the highest disbursement rate (69 percent) while transportation and energy had the lowest rates (10 percent and 3 percent, respectively).

Public investment disbursements to implementing agencies for these eight sectors accounted on average during the period 1994-September 1997 for only about 4.6 percent of GDP. For physical infrastructure (energy, multiple sectors, solid waste, transportation, and water and sanitation) investment disbursements were less than 3 percent of GDP.20 Such investment levels are significantly inadequate when account is taken of the poor initial state of the infrastructure and that developing countries on average spend 4 percent of GDP on basic infrastructure (i.e., transportation, electricity, communications, and water). It must, moreover, be noted that in rapidly growing economies, infrastructure investment levels amounting to 6 to 8 percent of GDP are common.

The lack of interest in the infrastructure in the West Bank and Gaza Strip was due not only to the vacillations in the peace process, which have on occasion resulted in shifting donor focus from investment projects and barriers to project implementation, but also lack of coordination between the Palestinian Authority and Israel. In particular, border closures caused shortages in materials and impediments to the movement of local and international personnel involved in project implementation. In addition, donors often focused more on short-term feasibility studies and technical assistance rather than on major infrastructure projects. Other aspects of Israeli-Palestinian relations (such as security considerations) also affected the implementation of major infrastructure projects, such as airport and port projects. Furthermore, in the early phase, weaknesses in official Palestinian institutions contributed to limited infrastructure investment projects. During most of 1994-97 Palestinian institutions and the Palestinian Authority were being set up and there was a limited sense of Palestinian ownership of public investment programs.

Recently, at the December 1997 Consultative Group meeting, the Palestinian Authority presented a $3.5 billion Palestinian Development Plan for the years 1998-2000, with 49 percent allocated for infrastructure and natural resource management, 25 percent for human resource and social development, 17 percent for productive sectors (such as agriculture and industrial development), and 9 percent for institution capacity building. Among infrastructure and natural resource management projects almost 50 percent ($831 million) is allocated for water and waste-water and 25 percent ($414 million) for transportation. The Palestinian Development Plan is novel in that its development objectives and priorities were identified and project selection criteria set in the context of a highly deliberative and participatory process involving all Palestinian Authority organs, as well as private sector representatives. Moreover, its preparation was carried out within an institutional framework involving collaboration both within the Palestinian Authority and between the Palestinian Authority and the donor community, especially the World Bank. The Palestinian Development Plan has also a medium-term orientation and places emphasis on the ongoing nature of the planning exercise. At the conclusion of the 1997 Consultative Group meeting, donors indicated their intention to commit about $750 million toward development activities in the West Bank and Gaza Strip in 1998, and a further $150 million in the form of guarantees for private investment. Even more important, the Palestinian Authority is in the process of instituting better, home-grown project follow-up mechanisms for the Palestinian Development Plan. Although these recent developments give encouragement to future disbursements for infrastructure projects, such improvements will require time.


This section focuses mainly on the corporate income tax as it has the most direct bearing on private sector activity.


Enterprises with a paid-up capital of more than $100,000 receive a two-year tax holiday; more than $150,000, three years; and more than $500,000, five years.


Businesses employing at least 10 workers are granted a two-year exemption; at least 15 workers, three years; and at least 25 workers, five years.


The IMF has provided detailed technical assistance to the Palestinian Authority on this issue. This section summarizes the main conclusions.


See, for example, W. Baumol, 1986, “Productivity Growth, Convergence, and Welfare: What the Long-Run Data Show,” American Economic Review, Vol. 76, pp. 1072-85; R. Barro, 1991, “Economic Growth in a Cross Section of Countries,” Quarterly Journal of Economics, Vol. 106, pp. 407-43; and X. Sala-i-Martin, 1996, “Regional Cohesion: Evidence and Theories of Regional Growth and Convergence,” European Economic Review, Vol. 40, pp. 1325-52.


In 1995 and 1996, budgetary expenditures on health and education represented about a third of total recurrent expenditures (in the range of 5-6 percent of GDP).


This section has benefitted from information contained in a discussion paper by the Palestine Economic Policy Research Institute (MAS), Health in Palestine: Potential and Challenges, March 1997, and in Chapter 12 of a World Bank draft paper, Development Under Adversity? The Palestinian Economy in Transition, May 1997.


For example, in the West Bank, the Ministry of Health currently spends about two-thirds of its budget allocation on hospital care and one-third on primary care.


While the Palestinian Authority has contributed to increasing the bed capacity and developing more care units in some hospitals, the building of new hospitals is largely funded by international donors who seem to prefer this type of support.


Data provided by staff of the Ministry of Health.


Data provided by officials of the Ministry of Health, and World Bank draft paper, Chapter 12, pages 10-12 (see footnote 7).


Data obtained from the Ministry of Health.


This section is based on information and data from the World Bank paper (see footnote 7), Chapter 11, and from a background paper by Berryman, The Education Story, 1996.


See Education Statistics in the West Bank and Gaza Strip, Palestinian Central Bureau of Statistics, Current Status Report Series No. 5, August 1995, Tables 7.23 and 7.24, pages 138-139; World Bank Population Projections; and The Demographic Survey in the West Bank and Gaza Strip, Palestinian Central Bureau of Statistics, preliminary report, March 1996, page 89.


Data obtained from discussions with Ministry of Education staff and from the World Bank report, Development Under Adversity? The Palestinian Economy in Transition, May 1997, Chapter 11, page 6. Although the teacher to student ratio is relatively low, it is not completely unacceptable by international standards.


Psacharopoulos, George, 1993, “Returns to Investment in Education: A Global Update,” World Bank Policy Research Working Paper, No. 1067.


Levine and Renelt (1992), “A Sensitivity Analysis of Cross-Country Growth Regressions,” American Economic Review, Vol. 82, pp. 942-63.


These and the following infrastructure comparison figures are based on data for the years 1992-94 and are from the World Bank report (see footnote 7).


Ministry of Planning and International Cooperation, MOPIC’s 1997 Third Quarterly Monitoring Report of Donor Assistance, November 28, 1997. These figures represent the status prior to the December 1997 Consultative Group for the West Bank and Gaza Strip. The sectoral break-down is according to MOPIC’s classification. Multiple sectors include projects that have components relevant in various sectors, such as World Bank projects and cofinancing for such projects by donors.


The ratios were 2.1 percent of GDP in 1994, 2.5 percent in 1995, and 2.8 percent in 1996. For 1997, taking into account the first three quarters, the ratio was 4.9 percent. Regarding the latter, however, it must be noted that the disbursements were to implementing agencies so that by year end the ratio probably declined.