# **1 Introduction**

## **Fiscal space for the Palestinian Authority (PA) has been shrinking for much of the past two decades and**

**is reaching a critically low level.** Economic shocks from COVID-19 and the Russian invasion of Ukraine have compounded negative effects from systemic constraints, recurring armed conflict, and declining external assistance. Despite relatively stronger public revenue mobilization in 2022, the PA faces persistent financing gaps. It has so far filled the gaps by accruing arrears to the private sector and public pension funds and by paying partial salaries to public employees, but these coping strategies are reaching their limits.<sup>3</sup> Recent decisions by the new Israeli government to increase deductions from clearance revenues<sup>4</sup> and withhold funds from previously collected revenues will likely increase the strain on PA budgets.<sup>5</sup>

**Fiscal policy choices in a constricted resource context affect the day-to-day lives and wellbeing of Palestinians.** In one current example, the PA halted payments to beneficiaries of the main social assistance program (the National Cash Transfer Program) for much of 2022—still delayed at the time of writing this report—to divert resources to other parts of the national budget. Meanwhile, the value of PA fuel subsidies jumped 191 percent in 2022 following the rise in global oil prices.<sup>6</sup> While this cost has since come down and remains modest compared to other countries in the region, this remains a significant fiscal risk. On taxation, efforts to expand fiscal space by increasing public revenue mobilization could risk increasing poverty and inequality if they impose too heavy a burden on lower-income taxpayers.

**Distributional analysis of fiscal choices offers valuable insights on how policies affect poverty and equity.** This is in line with calls to improve the fairness, effectiveness, and efficiency of public expenditure while prioritizing support to the most vulnerable.<sup>7</sup> The analysis complements ongoing reform initiatives under the World Bank’s current Development Policy Grant. Moreover, analyzing the distributional impact of fiscal policies on households’ welfare is an important part of monitoring the Sustainable Development Goal 10.4.2, which measures how countries’ fiscal systems contribute to inequality reduction.

**This report represents the first comprehensive fiscal incidence analysis in the West Bank and Gaza.** It uses the Commitment to Equity (CEQ) methodology to assess distributional repercussions of the main tax interventions and public social expenditures, including direct and indirect taxes, direct transfers and indirect subsidies, and in-kind benefits from the provision of public health and education services. The analysis is anchored in data from the most recent nationally representative Palestinian Expenditure and Consumption Survey (PECS) (2016/2017), as well as administrative data for the main taxes and social expenditure items in the West Bank and Gaza.

## **The analysis presented in this report seeks to answer four key questions:**

- How does the combination of taxes and transfers modeled affect poverty and inequality in the West Bank and Gaza?

- Which fiscal interventions are the most important in driving these effects?

- How progressive or regressive is each component of the fiscal system?

> 3 For further detail on the fiscal situation, see: World Bank (2022a), World Bank (September 2022).

> 4 Clearance revenues refer to revenue collected by Israel on behalf of and transferred to the Palestinian Authority.

> 5 World Bank (March 2023).

> 6 World Bank (March 2023).

> 7 World Bank (September 2022).

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