Abstract

After the creation of the Palestinian Authority (PA) in 1994, the most important task in the fiscal area was to secure a solid revenue base within the constraints imposed by the Oslo Accords and to establish mechanisms that would allocate resources efficiently to meet the needs of the Palestinian people, particularly for basic public services. At the outset, significant uncertainty surrounded the availability of financial resources. However, the PA was authorized to levy taxes and other fees in the territories under its control to finance its operations. Moreover, in the Economic Protocol of 1994, Israel and the PA agreed on a revenue clearance system.1 In addition, in support of the Middle East peace process, the international community pledged generous financial assistance to the Palestinians ($3.7 billion) for the first five years after the peace accords. Over $2.5 billion was disbursed by donors during the period 1994-98, most of which was devoted to public investment and institution building.

Introduction

After the creation of the Palestinian Authority (PA) in 1994, the most important task in the fiscal area was to secure a solid revenue base within the constraints imposed by the Oslo Accords and to establish mechanisms that would allocate resources efficiently to meet the needs of the Palestinian people, particularly for basic public services. At the outset, significant uncertainty surrounded the availability of financial resources. However, the PA was authorized to levy taxes and other fees in the territories under its control to finance its operations. Moreover, in the Economic Protocol of 1994, Israel and the PA agreed on a revenue clearance system.1 In addition, in support of the Middle East peace process, the international community pledged generous financial assistance to the Palestinians ($3.7 billion) for the first five years after the peace accords. Over $2.5 billion was disbursed by donors during the period 1994-98, most of which was devoted to public investment and institution building.

Fiscal Developments

The PA has been extremely successful in increasing fiscal revenue collection, which, together with efforts to contain the expansion of public expenditure, resulted in a virtually balanced current budget in 1998. Current fiscal revenue more than tripled during that time, reaching $863 million (25 percent of GDP) in 1998. Increased availability of fiscal revenue permitted a very fast expansion of current expenditure, part of which could be justified on grounds of expanded responsibilities and services. The continued rapid expansion in public sector employment since 1997 was excessive, however, and is a source of serious concern. Furthermore, despite the fact that current expenditure represents about 25 percent of GDP, the PA still relies on donor aid, on UNRWA, and on NGOs to provide some basic public services.2 Capital expenditure is still fully financed by donor aid, a situation that is likely to change over the medium term.

Revenue

Improved tax administration was the most important factor in securing a solid fiscal revenue base. Current fiscal revenue stood at 25 percent of GDP in 1998, up from only 8 percent in 1994, and was in line with other countries in the region (Table 3.1 and Figure 3.1). Efforts to improve tax administration led to increases in both domestically collected revenue and in revenue received from Israel through the clearance system. The latter constituted more than 60 percent of total revenue, a proportion that has remained broadly stable since 1995. The structure of current revenue has also remained stable. Indirect taxes representing about 80 percent of total revenue were the main source of current revenue in 1998. The VAT, together with custom duties and excise taxes on tobacco and petroleum, yielded almost all indirect taxation revenue: VAT revenue is estimated to have reached about 33 percent of total revenue in 1998, of which about 70 percent is clearance revenue. As to the composition of indirect taxes, the share of VAT in total revenue declined, while that of custom duties increased, although their combined contribution to total revenue over 1996-98 remained stable (Table 3.2 and Figure 3.2). This change in the composition of indirect taxes reflected improved customs administration and a shift from indirect to direct imports.3

Table 3.1

Fiscal Operations of the Palestinian Authority

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Sources: Palestinian and Israeli authorities; and IMF staff estimates.

On a cash basis. Includes collections transferred to bank accounts outside the control of the Ministry of Finance.

On a cash basis.

Excluding foreign-financed employment programs.

ln millions of U.S. dollars.

Figure 3.1
Figure 3.1

Current Revenue and Expenditure of the PA

Sources: Palestinian Authority; and IMF staff estimates.
Table 3.2

Current Fiscal Revenue of the Palestinian Authority

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Sources: Palestinian and Israeli authorities; and IMF staff estimates.

On a cash basis. Includes collections transferred to bank accounts outside the control of the Ministry of Finance.

In 1995, includes excises.

Figure 3.2
Figure 3.2

Comparison of Tax Revenue

(End 1998; in percent of GDP)

Sources: World Economic Outlook, Government Finance Statistics Yearbook; and IMF staff estimates.

The Revenue Clearance System1

Under the Protocol of Economic Relations, the two sides established a revenue clearance system to apportion an agreed pool of selected tax revenues. For indirect taxes, revenues accrue either to the Palestinian or the Israeli side according to the “destination principle,” and the transfer of such revenues is made on a regular basis after a reconciliation of accounts. For direct taxes, such as income taxes and health fees paid by Palestinian workers in Israel and in the Israeli-controlled areas, 75-100 percent of revenues collected at source are transferred. As the collecting agent, Israel levies a 3 percent service fee on all gross clearance revenue.

Transfers from the clearance system have been the most important source of revenue for the PA—more than 60 percent since 1995. Other than some minor problems at the early stages, the revenue clearance system has worked smoothly. The only significant interruption in the settlement of revenue clearances occurred during the border closures in the summer of 1997.

For indirect taxes, the revenue clearance system is based on actual payments or bookkeeping transactions. For custom duties, VAT, and purchase taxes on third-party goods that are imported by Palestinian entities and destined directly for the West Bank and Gaza, a coding sharing system used in import declarations has ensured that the correct fiscal revenues are properly transferred to the PA.

For VAT on Palestinian-Israeli transactions, the invoicing mechanism that supports the functioning of the VAT was a natural candidate for revenue clearance. Because the VAT is a multistage tax, each side agreed to recognize all invoice-supported VAT payments made to the other side to avoid tax cascading. This arrangement permits each tax authority to recover from its counterpart the amounts that are allowed to be deducted from VAT liabilities by firms in its own jurisdiction. This feature provides an incentive for both sides to widen the coverage of their respective VAT, because doing so will automatically increase the amount each can recuperate from the other side. This system, which requires considerable coordination, has functioned well following the introduction of a unified invoice system in January 1995.

For direct taxes, the Protocol specifies that 75 percent of the income taxes paid by Palestinian workers employed in Israel are to be transferred to the PA. This revenue-sharing formula recognizes the principle that income tax should be used in part to finance the social services consumed by the workers. As most Palestinian workers employed in Israel commute to work daily and are, therefore, more likely to consume their social services in the West Bank and Gaza, income tax deducted at the source from wages of Palestinian workers in Israel is shared between the two authorities. In addition, the Protocol further specifies that 100 percent of all health fees paid by Palestinian workers in Israel and in the Israeli-controlled areas be transferred to the PA in recognition of the service criterion.

1 Source Zavadjil and others (1997) with updates.

Expenditure

Progress in public expenditure management was considerably slower than that achieved in tax administration. Current expenditure increased rapidly since the inception of the PA, to about 25 percent of GDP in 1998, up from 9 percent in 1994.4 It must be noted however that, although the level of current expenditure as a percentage of GDP was broadly in line with the levels in neighboring countries, in 1998 the PA still was not providing all basic public services (Figure 3.3). Moreover, in the absence of adequate procedures and mechanisms for expenditure management and control, there is no assurance that further revenue gains would not be used to support correspondingly higher current expenditure, in particular wage expenditure.

Figure 3.3
Figure 3.3

Comparison of Current Expenditure

(End 1998; in percent of GDP)

Sources: World Economic Outlook, Government Finance Statistics Yearbook; a IMF staff estimates.

Public sector employment has more than doubled since the PA was established. In the beginning, the increase could be explained on four grounds: expanded responsibilities, a need for improved public services over those formerly provided by the ICA, the need to create a security force (police) in the territories under its control, and the restriction on mobility between the West Bank and the Gaza Strip that necessarily resulted in the duplication of some functions. The PA also assumed responsibility for the provision of some public services that previously had been provided by NGOs. After 1996, strong political pressure to alleviate unemployment coupled with weak controls on the hiring process of public employees appear to have been the main causes behind the fast expansion of the public sector payroll (see Box 3.2). Partly as a result of the significant decline in employment opportunities in Israel, a fast-growing labor force, and a large inflow of Palestinian expatriates returning to the West Bank and Gaza after the Oslo Accords, unemployment rose sharply in 1995-96. It has subsequently dropped substantially, but remained high at about 15 percent in 1998. Hence, the PA remained under strong pressure to provide jobs to returning expatriates and to alleviate job losses when economic activity sharply declined during closures. By the end of 1998, employment by the PA exceeded 92,000 and represented more than 15 percent of the labor force, while the 1998 PA wage bill reached almost $470 million (nearly 55 percent of current expenditure), which is high by international standards (Figure 3.4). The rapid increase of the wage bill effectively prevented the PA from contributing its own resources to the public investment program.

Figure 3.4
Figure 3.4

Comparison of Public Sector Wage Bill

(End 1998; in percent of current expenditure)

Sources: World Economic Outlook, Government Finance Statistics Yearbook; and IMF staff estimates.1 Includes military wage bill.

Current Balance

Revenue performance during 1994–98 was better than envisaged, and efforts by the PA to control expenditure resulted in a virtually balanced current budget in 1998. This was a considerable achievement compared with current budget deficits of $95 million (2.8 percent of GDP) in 1996, and $29 million (1 percent of GDP) in 1994.5 As a result, no recurrent budgetary support was needed, and donors indicated that future aid would be redirected to finance capital expenditure. In spite of the improvement in the financial position of the PA, however, the Ministry of Finance continued to face a tight liquidity position because of the diversion of excise tax revenue to accounts outside its control.6 In general, these resources were only partially transferred to the Ministry on an ad hoc basis when the liquidity situation became untenable. To cope with its liquidity problems, the Finance Ministry had to resort to domestic bank borrowing and arrears accumulation, mostly on nonwage expenditures. The stock of arrears fluctuated significantly over time; by the end of 1997, almost all arrears had been cleared, but by the end of 1998 the stock stood at $68 million (1.9 percent of annual GDP). At that point, the Ministry of Finance had accumulated $169 million in liabilities with the domestic banking system (8 percent of private sector deposits or 22 percent of total bank lending), most of which was in the form of bank overdrafts ($157 million).

Capital Expenditure

Public investment of the PA reached $205 million (5.8 percent of GDP) in 1998, compared with $121 million (3.2 percent of GDP) in 1994. Despite a 70 percent increase in public investment, its current level is still too low to meet the infrastructure needs of the Palestinian economy. This investment has been, so far, fully financed by donor aid. Already in 1997, the PA stated its intention to start contributing its own resources to help finance capital expenditure; however, such a contribution has not yet been made. Efforts to generate a recurrent budget surplus have been undermined by the rapid expansion in the wage bill, beyond what would have been warranted by the need to put in place basic social services, preempting resources that might have been devoted to public investment.

Progress in Institution Building

The PA was aware from the outset that the strength of its institutional arrangements would be crucial to the effectiveness of fiscal policy.7 Raising adequate fiscal revenue requires not only sound tax policies, but a modern system of tax administration. Similarly, efficient use of resources available to the fiscal authorities depends on both public expenditure policies and management. The PA inherited a set of policies and institutional arrangements from the ICA, but it was evident that meeting the new challenges called for revisions and significant efforts in institution building, a process that requires time.

Tax Policy and Administration

In the early years, the compelling need to raise revenue quickly led the authorities to focus their efforts on improving tax administration rather than revising existing tax policies.8 The main objectives in the area of tax administration were to establish the revenue clearance system with Israel and to set up mechanisms to mobilize domestic tax revenue. From the first year of operation, a unified invoice system jointly operated with the Israeli tax authority worked extremely well and greatly facilitated the set-up of a well-functioning revenue clearance system.9 Early gains in domestic taxation stemmed from the implementation of a tax arrears settlement program, improvements in enforcement provisions in the legislation, recruitment of qualified staff, computerization of processing systems, and a campaign for taxpayer registration. Further measures in tax administration included the creation of a large taxpayer unit, a delinquent taxpayer unit, the implementation of an appeals system, the creation of an import reconciliation unit, and the establishment of a tax court. These measures enabled the PA to establish a well-functioning tax administration system within a very short period of time.

Public Sector Employment

Following the Oslo Accords, the Palestinian Authority assumed a number of public service responsibilities in the territories transferred from Israel, including the provision of education and health services and public security. As the PA progressively took over these responsibilities, public employment rapidly increased beyond the levels of the Israeli Civil Administration (ICA). Part of this rapid increase can be justified on four grounds: expanded responsibilities; a need for improvements in public services, which were inadequate under the ICA; the need to create a security (police) force; and the restrictions on mobility between the West Bank and the Gaza Strip that necessarily results in the duplication of some functions.

The PA was faced with a stagnating economy, rising unemployment, weak institutional controls, and the need to provide employment to former PLO and Palestine Liberation Army (PLA) repatriates. It has, therefore, found it difficult to resist pressures to substantially expand public employment even during years when no new responsibilities were transferred from Israel, such as 1997. By the end of 1998, public employees had increased to more than 92,000 (16 percent of labor force) from about 40,000 in 1994, and 74,000 in 1996.

The increase in the wage bill has significantly reduced the amount of resources available for non-wage expenditure, which in 1998 represented 46 percent of total recurrent expenditure on a commitment basis (42 percent on a cash basis), compared with 49 percent in 1996. The composition of expenditure is even worse at some key ministries, such as the Ministry of Education, where the wage bill represents over 90 percent of the Ministry’s spending.

Public Expenditure Policy and Management

Expenditure policies in the West Bank and Gaza required a major overhaul: more resources were needed for health and education, and a security (police) force had to be established. Progress in public expenditure management has not been as marked as on the revenue side. The main difficulties have been in establishing a well-structured budgetary process, creating treasury and internal audit units, computerizing an expenditure control and reporting system, strengthening procedures for the recruitment of public employees, and consolidating all fiscal receipts in one account under the control of the Ministry of Finance. It was only in 1997 that the first budget received due approval process, including approval by the Palestinian Legislative Council (PLC), although the 1998 budget covered only current expenditure; procedures for proper public investment budgeting are not yet fully developed. The Organic Budget Law was approved in mid-1998, but regulations were still pending by early 1999. The placement of financial comptrollers in spending ministries has been slow, although progress is expected. The government financial management and information system (GFMIS) is still being implemented. Clearly defined procedures were established to regulate the recruitment of public employees, but these procedures are not yet strictly enforced.10 In June 1998, the PLC approved a new Civil Service Law which incorporated positive changes, including the transfer of full control over the payroll in the Gaza Strip to the Ministry of Finance, and the streamlining of the civil service. The effective transfer of the control over the Gaza payroll has yet to be made, however. The new salary scale, which was approved as part of the regrading of civil servants envisaged in the law, will entail a substantial fiscal cost, however (see Boxes 3.3 and 3.4).

The New Civil Service Law

The fast expansion of public employment since 1994 has been partly due to the lack of appropriate controls in the recruitment of public employees and in the administration of the public payroll. The authorities have made efforts to correct this problem, and in May 1998 a new Civil Service Law was approved that aimed at creating a unified civil service and upgrading its administration to international standards. The law has not yet been implemented because the by-laws and regulations are still being developed.

The new law envisages significant changes in public employment administration, including transferring control over the payroll administration in the Gaza Strip from the General Personnel Council (GPC) to the Ministry of Finance, defining different entities’ roles in managing their staff, and streamlining the organization of the civil service. In this regard, the law creates five categories of civil employees, each of which is divided into subcategories.

The law also aims at enhancing transparency in civil service administration and improving performance incentives for civil servants. It defines the necessary academic qualifications for different categories of employees. The law also defines the nature of, and qualification criteria for, different allowances. It creates a merit allowance for civil servants with sustained outstanding performance, and for those who propose efficiency improvements and cost-reducing measures. The law calls for a unified evaluation process and increases the role of performance evaluation for promotions within and between categories. The unified evaluation process is still being devised and will be governed by regulations still to be issued.

While the law constitutes an important step toward improving civil service administration, the authorities should carefully assess the desirability and feasibility of adopting the new salary scale established in the law. Despite provisions in the law allowing the PA to phase in the new salary scale over several years and as fiscal resources allow, its full implementation would entail an additional fiscal cost estimated at $145-270 million a year (4.4-8.8 percent of current GDP). In the last two months of 1998, the new salary scale was partially implemented, providing an average wage increase to civil servants of 14 percent. The individual wage increase was inversely related to the employees’ grade. Employees at the lowest end of the pay scale received a monthly increase of NIS 300, while their counterparts at the highest end of the pay scale received an increase of NIS 50. The authorities estimate that in 1999 the cost of the partial implementation of the law could be limited to about NIS 14 million on a monthly basis ($42 million) on an annual basis.

Expenditure control and cash management have been severely affected by the continued diversion of fiscal revenue to accounts outside the control of the Ministry of Finance. Little progress has been made so far in addressing the situation. The diversion has led to recurrent liquidity problems for the Ministry of Finance, which has had to resort to accumulating payment arrears and domestic bank financing, mainly in the form of bank overdrafts.

The Challenges Ahead

Fiscal Policy

In the coming years, the PA will have to conduct fiscal policy in a radically different environment. The remarkable gains in revenue collection achieved since 1994 are not likely to be repeated, setting a limit on future expenditure growth and increasing the need to prioritize.

Public Expenditure Review

In view of the limited prospects for additional gains in tax administration and for increases in fiscal revenue, as well as the need of the PA to fulfill its existing and rapidly increasing obligations, the World Bank has prepared an assessment of the sustainability of current public expenditure policies and management in the West Bank and Gaza. The main findings and recommendations are summarized in this box.1

The Public Expenditure Review (PER) found that significant improvements are still to be made in public expenditure policy and management. Because public expenditure was used to mitigate the effects of adverse economic conditions, public employment expanded beyond what could be justified by the new obligations of the PA, and currently represents the highest percentage of the labor force in the region. The report found that public employment growth was not only due to a deliberate policy but to ad hoc management of the budget because of institutional weaknesses in recruitment procedures. The composition of public employment has also been affected: for instance, while school enrollment has rapidly increased, the ratio of teaching to nonteaching staff in the education sector has continuously declined since 1994.

The report groups its recommendations to improve budget management into three categories:

  • improvements in institutional arrangements, which would not only improve the allocation of fiscal resources, but would also contribute to enhancing governance and transparency;

  • prioritizing expenditure, which would play a fundamental role in the budgetary process and in the monitoring of budget implementation; and

  • efficient and effective delivery of public services, for which the report discusses alternatives to the direct involvement of the central government.

Regarding governance and transparency, the report highlights the significant progress that has occurred in increasing accountability, and gives due credit for this progress to the PA and the PLC. Important steps in this area include the approval of the budget with due legislative process since 1997; the development and approval in 1998 of the Organic Budget Law, which provides a framework for budget management; and the publication of an annual report from the General Control Institution (comptroller agency).2 Progress was made in enforcing the separation of responsibilities for expenditure commitments and payments. Further efforts are needed in improving the budgetary process and in increasing accountability between the executive and legislative branches. In relation to the former, the report points out that the budget is still not comprehensive both in expenditure and revenue. On the other hand, revenue from the commercial operations of the PA are still not incorporated in the budget.

1World Bank (1999).2 Since 1997, the General Control Institution has published only one report.
  • The PA will eventually have to take over responsibility for some of the public services currently provided by donors and NGOs. For instance, in the Ministry of Education the wage bill absorbs more than 90 percent of the allocated budget, while UNRWA provides health services and primary education in refugee camps in the West Bank and Gaza. In the context of declining external aid, substantial efforts to rationalize expenditure would be required to protect and possibly increase high priority out-lays, including social expenditure.

  • The PA will have to finance a growing share of the public investment program out of its own resources because donor financing will not be available indefinitely. This requires building a surplus in the current budget and resisting pressures to increase government expenditure and reduce taxes. Tax reforms should aim at promoting economic efficiency and improving equity. Over the next few years, such reforms should be revenue neutral.

  • Special attention will have to be given to public employment and the wage bill, which grow necessarily at the expense of nonwage expenditure. The expansion of public employment poses the greatest threat to fiscal policy soundness: the wage bill accounted for nearly 55 percent of expenditure in 1998, and the current growth rate is clearly unsustainable. Pressures have been mounting to grant wage increases, and these are likely to intensify. The civil service law approved in mid-1998 envisaged wage increases by incorporating a regrading exercise of public employees that would have an estimated fiscal cost of $145-270 million (4.1-7.7 percent of 1998 GDP) if fully implemented (see Boxes 3.3 and 3.4). The PA will also have to devise more efficient ways of addressing the unemployment problem, such as through temporary public works programs.

  • Fiscal policy decisions must be made with a view to ensuring sustainability over the medium term.11 First, although continued assistance is envisaged in the coming years following new aid pledges for $3.3 billion in November 1998 in Washington, D.C., Palestinian economic development cannot be based on the assumption that donor aid on this scale will continue indefinitely. Second, some economic policy decisions entail important consequences for future expenditure. For instance, the existing, and actuarially unsound, pension systems constitute large implicit liabilities. Thus, pension reform should be a priority (see the Annex on Pension Issues).

Institution Building

In the years to come, the authorities will have to consolidate gains in tax administration and shift their attention to improving existing tax policies. Regarding tax administration, most gains will come from enhancing tax compliance controls to reduce tax evasion. In addition, progress is still to be made in unifying the West Bank and Gaza tax administrations, integrating the income tax and VAT administrations, and introducing the Palestinian Authority tax administration computer system (PATACS). As for tax policies, the authorities have been working on income taxation, and a new income tax law is expected to be approved in 1999.12 In any case, revenue as a percentage of GDP is already quite high for a developing country by international standards. Further increases might pose a threat to growth. Thus, significant efforts are required to strengthen public expenditure management: continued ad hoc expenditure management is not sustainable, given the limits of revenue generation and the need to gradually reduce reliance on donor aid. Improvements in governance and greater transparency in fiscal operations are also needed. The budgetary process should be improved further by, inter alia, the adoption of explicit criteria to prioritize both current and capital expenditure requests, and the upgrading of treasury operations. Controls over spending ministries and improved auditing procedures are fundamental to guaranteeing the appropriate use of fiscal resources. Especially important is implementing controls on the recruitment of public employees; transferring full control over the payroll in the Gaza Strip to the Ministry of Finance; and reassessing the regrading exercise approved in the Civil Service Law, with a view to adopting a more affordable increase in public wages. In addition, the authorities need to establish a debt management unit in the Ministry of Finance. In past years, this has not been a high priority because most external resources have been in the form of grants. However, as the PA is starting to receive a larger share of external financing in the form of loans rather than grants, adequate debt management will be necessary.

Finally, the consolidation of all public accounts under the control of the Ministry of Finance should be given utmost importance. The existence of accounts outside its control is probably the issue that raises the most doubts about governance and transparency within the PA. In addition, the related accumulation of arrears and excessive resort to domestic bank financing are disruptive and could hinder economic growth.

1

Under the revenue clearance system, each party recovers from the other party’s tax authority some taxes paid by persons and firms in their respective jurisdiction. Currently, the PA receives net transfers from the Israeli treasury on a regular basis. For details, see Box 3.1.

2

In 1998, current expenditure reached $803 million, 23 percent of GDP, on a cash basis. However, $63 million in arrears was accumulated during the year, bringing current expenditure on a commitment basis to $866 million, 25 percent of GDP.

3

Under the revenue clearance system, Israel and the PA share customs duties on imports from third parties according to the final destination principle. In the case of direct imports, the PA receives the import tariff, VAT, and the purchase tax on imported goods, while for indirect imports (namely goods imported through Israel that do not state the West Bank and Gaza as the final destination on the Israeli customs declaration form), the PA receives only the VAT. In recent years, the PA has taken measures to improve monitoring, leading to an increase in the proportion of direct imports.

4

These figures are not comparable, however, because in 1994 the PA only provided services in Jericho, and subsequently its responsibilities have increased.

5

On a cash basis, the PA registered a surplus of $60 million in 1998; however, $63 million was accumulated in arrears, bringing the balance on a commitment basis to a small deficit of $3 million.

6

In practice, revenue from excise taxes domestically collected and on petroleum collected by Israel are transferred to PA accounts that are not under the control of the Ministry of Finance.Table 3.1 treats the net diversion of these funds as a negative financing item, therefore, implicitly assuming that these funds are saved.

7

Institution building efforts have already paid off in several key areas. The Ministry of Finance continues to consolidate its strong revenue performance and improve budgeting and expenditure management procedures.

8

The Economic Protocol imposed limitations on tariffs and the VAT rate in the autonomous territories. The customs union with Israel limited the scope of trade policy available to the PA to a short list of products. In addition, the VAT rate could not be lower than 2 percentage points below the 17 percent rate prevail’ ing in Israel.

9

The only significant interruption in the settlement of revenue clearances occurred during the closures in the summer of 1997. The EU then made available to the PA a short-term credit facility aimed at preventing disruptions in its functioning.

10

A ministerial committee on public employment reform was set up to monitor the implementation of a partial hiring freeze. The only exceptions to the freeze are those jobs necessary to meet the technical needs of the ministries of education (teachers) and health, as well as the judiciary.

11

Government solvency is defined as the set of policies that satisfies its intertemporal budget constraint, which means that ex ante the present value of the expected primary surpluses be equal to the initial stock of net public debt. In itself, such a budget constraint imposes fairly weak restrictions on policies. It is always met ex post through the adjustment of the primary fiscal position or various forms of debt repudiation. Fiscal sustainability, on the other hand, is defined as the set of fiscal policies a government can continuously pursue, all other things being equal, without the need for future reversals. Sustainable fiscal policies must satisfy the solvency constraint, but the inverse is not necessarily true.

12

In early March 1999, a Presidential decree reduced, retroactive to January 1, 1999, the tax rates and the number of income tax brackets of personal income tax to four (5 percent, 10 percent, 15 percent, and 20 percent). The new income tax law is expected to incorporate these changes and to increase the number and amount of exemptions. The law also unifies the existing income tax laws in the West Bank and Gaza, and envisages improved enforcement provisions.

Economic Developments in the Five Years Since Oslo