metadata: authors: 0: author: Amjad,Beenish
1: author: Carrasco Nunez,Haydeeliz
2: author: Finn,Arden Jeremy
3: author: Goldman,Maya Scott
count: West Bank and Gaza
docna: 0: docna: Fiscal Policy, Poverty, and Inequality in a
            Constrained Environment : The Case of the West Bank and Gaza
docty: Policy Research Working Paper
theme: Data production, accessibility and use,Gender,Human Development and Gender,Data Development and Capacity Building,Economic Policy,Rural Development,Fiscal Policy,Institutional strengthening and capacity building,Public Sector Management,Fiscal sustainability,Urban and Rural Development,Geospatial Services
abstracts: cdata!: This report analyzes the distributional
            impacts of the main taxes and transfers on
            households&#x2019; welfare in the West Bank and Gaza.
            The analysis uses the Commitment to Equity methodology,
            enabling comparison of the results to other countries where
            this framework has been applied. The report assesses the
            effects of government taxation, social expenditure, and
            indirect subsidies on poverty and inequality in the West
            Bank and Gaza. The results indicate that the combination of
            taxes and transfers modelled in the West Bank and Gaza
            reduces inequality by 6.5 Gini points but increases the
            national poverty headcount by 8.4 percentage points. These
            fiscal policy outcomes on poverty and inequality reduction
            are below average in terms of desirability compared to other
            lower-middle-income countries. The taxes and transfers
            modelled in the West Bank and Gaza achieve most inequality
            reduction through in-kind benefits from public basic
            education and public hospitals, followed by the Cash
            Transfer Program and the value-added tax (VAT). Their large
            impact on inequality reduction is explained by a combination
            of their progressivity and their size relative to household
            income. The redistributive effect of direct taxes, customs
            duties, and indirect subsidies is zero or close to zero.
            Indirect taxes represent the fiscal interventions
            contributing most to the increase in national poverty;
            customs duties followed by VAT represent the largest burden
            on households&#x2019; incomes. Direct transfers from
            social protection cannot offset the impoverishment effect
            from indirect taxes because they have very limited coverage.
            Only the poorest decile is a net cash beneficiary after
            paying taxes and receiving cashable transfers.   The rest of
            the deciles are net payers to the fiscal system. To decrease
            poverty and inequality in the West Bank and Gaza, the most
            significant policy recommendation to emerge from the
            analysis is to expand direct transfers to the second and
            third deciles to compensate for indirect tax burdens.
            Financing this reform is feasible through domestic tax
            mobilization or through rationalization of inefficient fuel
            and electricity subsidies that benefit the top income
            deciles most.
display_title: Fiscal Policy, Poverty, and
            Inequality in a Constrained Environment : The Case of the
            West Bank and Gaza
listing_relative_url: /research/2024/01/34248497/fiscal-policy-poverty-inequality-constrained-environment-case-west-bank-gaza
topicv3: Poverty m1326687 695,Fiscal Incidence Analysis m1326940 711,Taxation m1327615 1121,Inequality and Shared Prosperity m1327655 700
publishtoextweb_dt: 2024-01-30T00:00:00Z
dois: 10.1596/1813-9450-10687
origu: Off of Sr VP Dev Econ/Chief Econ (DECVP)
no_of_pages: 79
author_keys: 0: author_key: 1959425
1: author_key: 1599475
2: author_key: 1594966
3: author_key: 1712768
model_extractions: Policy Research Working Paper 10687 Fiscal Policy, Poverty, and Inequality in a Constrained Environment The Case of the West Bank and Gaza _Beenish Amjad Haydeeliz Carrasco Arden Finn Maya Goldman_ Poverty and Equity Global Practice January 2024 A verified reproducibility package for this paper is available at http://reproducibility.worldbank.org, click **here** for direct access.
Policy Research Working Paper 10687

# **Abstract**

This report analyzes the distributional impacts of the main taxes and transfers on households’ welfare in the West Bank and Gaza. The analysis uses the Commitment to Equity methodology, enabling comparison of the results to other countries where this framework has been applied. The report assesses the effects of government taxation, social expenditure, and indirect subsidies on poverty and inequality in the West Bank and Gaza. The results indicate that the combination of taxes and transfers modelled in the West Bank and Gaza reduces inequality by 6.5 Gini points but increases the national poverty headcount by 8.4 percentage points. These fiscal policy outcomes on poverty and inequality reduction are below average in terms of desirability compared to other lower-middle-income countries. The taxes and transfers modelled in the West Bank and Gaza achieve most inequality reduction through in-kind benefits from public basic education and public hospitals, followed by the Cash Transfer Program and the value-added tax (VAT). Their large impact on inequality reduction is explained by a combination of their progressivity and their size relative to household income. The redistributive effect of direct taxes, customs duties, and indirect subsidies is zero or close to zero. Indirect taxes represent the fiscal interventions contributing most to the increase in national poverty; customs duties followed by VAT represent the largest burden on households’ incomes. Direct transfers from social protection cannot offset the impoverishment effect from indirect taxes because they have very limited coverage. Only the poorest decile is a net cash beneficiary after paying taxes and receiving cashable transfers. The rest of the deciles are net payers to the fiscal system. To decrease poverty and inequality in the West Bank and Gaza, the most significant policy recommendation to emerge from the analysis is to expand direct transfers to the second and third deciles to compensate for indirect tax burdens. Financing this reform is feasible through domestic tax mobilization or through rationalization of inefficient fuel and electricity subsidies that benefit the top income deciles most.

This paper is a product of the Poverty and Equity Global Practice. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://www.worldbank.org/prwp. The authors may be contacted at afinn1@worldbank.org. A verified reproducibility package for this paper is available at http://reproducibility.worldbank. org, click **here** for direct access.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# Fiscal Policy, Poverty, and Inequality in a Constrained Environment: The Case of the West Bank and Gaza<sup>1</sup>

Beenish Amjad Haydeeliz Carrasco Arden Finn<sup>2</sup> Maya Goldman This paper was finalized prior to the conflict in the Middle East that started in October 2023. Given the rapid pace of events and the possible changes to the enabling environment, some of the article’s analytics, assessments, and policy recommendations may not fully reflect the latest developments, and in a number of cases, the challenges raised in the paper may have been exacerbated by the hostilities. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily reflect the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent.

> 1 **Acknowledgements** : This report was written under the overall guidance of Johannes Hoogeveen and Alan Fuchs. We are grateful to Alia Jane Aghajanian, Eduardo Malasquez, Gianluca Mele and Nur Nasser Eddin for their contributions, and to Jessica Marie Anderson, Hamza Mighri, Sami Miaari, Haytham Abushaham and Ntuthuko Hlela for their support with data collection and research assistance. We are also thankful to the many World Bank colleagues and staff at the Palestinian Ministry of Finance and the Palestinian Central Bureau of Statistics who generously provided the information and data needed to finalize this work. Jon Jellema, Gabriela Inchauste and Matthew Wai-Poi provided insightful peer review comments that have greatly improved this report.

> 2 Corresponding author: afinn1@worldbank.org
# **Table of Contents**

|1<br>Introduction ...................................................................................................................................... 5|
|---|
|1.1<br>Six Key Findings ............................................................................................................................. 7|
|2<br>Tax revenue and public expenditure .............................................................................................. 10|
|2.1<br>Overview of the fiscal system ..................................................................................................... 10|
|2.2<br>Pensions ...................................................................................................................................... 12|
|2.3<br>Tax revenues ............................................................................................................................... 13|
|2.3.1<br>Direct taxes ......................................................................................................................... 13|
|2.3.2<br>Indirect taxes ....................................................................................................................... 14|
|2.4<br>Transfers ..................................................................................................................................... 15|
|2.4.1<br>Direct transfers ................................................................................................................... 15|
|2.4.2. Indirect subsidies .......................................................................................................................... 16|
|2.5<br>In-kind benefits ........................................................................................................................... 18|
|2.6<br>International comparison ........................................................................................................... 18|
|3<br>Data and methodology ................................................................................................................... 21|
|3.1<br>Data sources ................................................................................................................................ 21|
|3.2<br>Commitment to Equity (CEQ) framework ................................................................................... 21|
|4<br>Methodologies for allocating taxes and transfers .......................................................................... 26|
|4.1<br>Pensions ...................................................................................................................................... 26|
|4.2<br>Direct transfers ........................................................................................................................... 27|
|4.3<br>Direct taxes ................................................................................................................................. 27|
|_4.3.1_<br>_Personal income tax (PIT)_.................................................................................................... 27|
|_4.3.2. Property tax_............................................................................................................................... 29|
|4.4. Indirect taxes .................................................................................................................................... 29|
|4.4.1. Customs..................................................................................................................................... 29|
|4.4.2. VAT ............................................................................................................................................ 29|
|4.4.3. Excises ....................................................................................................................................... 31|
|4.5. Indirect subsidies ............................................................................................................................. 31|
|4.5.1. Domestic electricity .................................................................................................................. 31|
|4.5.2. Fuel subsidies ............................................................................................................................ 32|
|4.6<br>In-kind benefits ........................................................................................................................... 33|
|5<br>Headline results .............................................................................................................................. 35|

1
|5.1<br>Poverty and inequality ................................................................................................................ 35|
|---|
|5.2<br>Fiscal impoverishment ................................................................................................................ 37|
|5.3<br>Net cash beneficiaries ................................................................................................................. 39|
|6<br>Marginal contributions and progressivity ....................................................................................... 41|
|6.1<br>Marginal contributions ............................................................................................................... 41|
|6.1.1<br>Inequality ............................................................................................................................ 41|
|6.1.2<br>Poverty ................................................................................................................................ 43|
|6.2<br>Progressivity ................................................................................................................................ 45|
|7<br>Incidence and concentration shares by decile ................................................................................ 48|
|7.1.<br>Taxes ........................................................................................................................................... 48|
|7.2.<br>Transfers ..................................................................................................................................... 50|
|8<br>International comparison ............................................................................................................... 53|
|8.1<br>Inequality .................................................................................................................................... 53|
|8.2<br>Poverty ........................................................................................................................................ 53|
|9<br>Macro-validation and limitations of the analysis ............................................................................ 55|
|9.1<br>Macro-validation ......................................................................................................................... 55|
|9.2<br>Limitations................................................................................................................................... 57|
|9.2.1<br>Direct taxes and pension contributions .............................................................................. 57|
|9.2.2<br>Indirect taxes ....................................................................................................................... 58|
|9.2.3<br>Indirect subsidies ................................................................................................................ 58|
|9.3<br>Direct transfers ........................................................................................................................... 59<br> <br>|
|9.3.1<br>Education ............................................................................................................................ 59|
|9.3.2<br>Health .................................................................................................................................. 59|
|10<br>Conclusion and next steps .............................................................................................................. 60|
|10.1<br>Conclusion ................................................................................................................................... 60|
|10.2<br>Next steps ................................................................................................................................... 61|
|References .................................................................................................................................................. 62|
|Annex A: Pensions as deferred income versus pensions as a government transfer .................................. 66|
|Annex B: Methodology for allocating PIT deductions ................................................................................ 69|
|Annex C: Marginal Contributions at Market, Disposable and Consumable income ................................... 75|

2
|Figure 1-1 Poverty and inequality are higher in Gaza than in the West Bank .............................................. 6|
|---|
|Figure 2-1 Tax revenues as a share of GDP are higher than the sample average at 20.7 percent ............. 19|
|Figure 2-2 Social expenditures as a share of GDP are higher than the sample average at 14.1 percent ... 20|
|Figure 3-1 Income concepts in the CEQ framework ................................................................................... 24|
|Figure 5-1 The national poverty headcount increases by 8.4 percentage points from Market to<br>Consumable Income ................................................................................................................................... 36|
|Figure 5-2 The Gini coefficient decreases by 6.5 Gini points from Market to Final Income ...................... 37|
|Figure 5-3 Over two thirds of the market poor population experiences net fiscal gains due to fiscal policy<br>.................................................................................................................................................................... 39|
|Figure 5-4 Households in decile 1 are net cash beneficiaries of fiscal policy in the West Bank and Gaza . 40|
|Figure 6-1 Almost all fiscal instruments in the West Bank and Gaza are either inequality-reducing or have|
|no effect ...................................................................................................................................................... 43|
|Figure 6-2 In the West Bank and Gaza, direct transfers and the direct effects of electricity subsidies are<br>the only poverty-reducing instruments ...................................................................................................... 44|
|Figure 6-3 All transfers are progressive, except for fuel subsidies and pension income ........................... 46|
|Figure 6-4 All taxes are progressive. The PIT is the most progressive tax, however the direct effects of<br>fuel excises are the most progressive component of the fiscal system. .................................................... 47|
|Figure 7-1 Of all taxes, the Customs Tax and VAT have the largest incidence across the distribution ...... 49|
|Figure 7-2 Cash transfers provide the largest benefits to the poorest decile ............................................ 51|
|Figure 8-1 Total inequality reduction in the West Bank and Gaza is moderate relative to countries in<br>other CEQ assessments ............................................................................................................................... 53|
|Figure 8-2 Total poverty impact at the $5.50 line is severe relative to countries in other CEQ assessments<br>.................................................................................................................................................................... 54|
|Table 2-1 Total revenue and government expenditure in the West Bank and Gaza in 2017 is 27.0 and<br>27.4 percent, respectively, of GDP ............................................................................................................. 10|
|Table 2-2 There are three pension schemes applicable in the West Bank and Gaza, and one pension<br>scheme for Palestinian employees working in Israel and the settlements ................................................ 12|
|Table 2-3 The income tax framework in the West Bank and Gaza has only three brackets, and statutory<br>rates range between 5 and 15 percent....................................................................................................... 14|
|Table 2-4 The price of electricity per kWh for domestic consumers ranges between 0.458 and 0.6731 in<br>the West Bank and Gaza ............................................................................................................................. 16|
|Table 4-1: Scaling is applied to deductions to prevent an under-allocation of PIT in the survey .............. 28|
|Table 4-2 The estimated electricity subsidy per kWh ranges from 0.178 to -0.0371 in the West Bank and<br>Gaza............................................................................................................................................................. 32|

3
Table 9-1 The ratio of the amount allocated in the survey to the amount recorded in the budget ranges from 43% (for the electricity subsidy) to 124% (for pension income) ........................................................ 56 4
# **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).

5
- How can we predict and model potential policy reforms using this study as a base?

**The analysis comes at a time when poverty in the Palestinian territories remains elevated after the COVID-19 shock and has become increasingly concentrated in Gaza.** Based on the PECS 2016/2017, about 29.2 percent of the Palestinian population lived on household consumption levels below the national poverty line of NIS 2,470 per month for a reference household of two adults and three children (equivalent to about US$7.92 in 2017 PPP per day per capita). About 20.5 percent lived on household consumption levels below the Upper Middle Income Class Poverty Line of US$6.85 (2017 PPP) per day per capita. However, poverty rates differed substantially by region: 13.9 percent of Palestinians in the West Bank (including East Jerusalem) and 53.0 percent of Palestinians in Gaza lived below the national poverty line (Figure 1-1).<sup>8</sup> Consequently, the Palestinian poor have increasingly concentrated in Gaza. GDP per capita measured in 2017 PPP dollars had been increasing steadily since 2004, but poverty-reduction has been achieved primarily in the West Bank. Poverty rates in Gaza remain persistently higher and increased markedly from 2011 to 2016-17. Inequality as measured by the Gini coefficient was relatively low at 0.30 nationally in 2016-17, and slightly higher in Gaza with respect to the West Bank. Since 2016-17, poverty rate estimates spiked during the peak of the COVID-19 pandemic, and while they have gradually declined, they have not yet recovered to pre-pandemic levels.

# **Figure 1-1 Poverty and inequality are higher in Gaza than in the West Bank**

Poverty and Inequality in the West Bank and Gaza, 2017 Panel a: Poverty by location Panel b: Inequality by location <!-- Start of picture text --> 53.0<br>0.3<br>0.27 0.28<br>29.2<br>13.9<br>West Bank Gaza National West Bank Gaza National<br>Gini coefficient (0-1)<br>Below national poverty line (%)<br><!-- End of picture text --> Source: World Bank calculations based on PECS 2016/17.

Note: Poverty calculated based on real consumption per capita. National poverty line establishes different thresholds based on different combinations of numbers of adults and children in the data. Gini calculated based on real consumption per adult equivalent.

**The growing regional poverty disparity reflects geographic, administrative, and economic fragmentation.** East Jerusalem has been under Israeli administration and domestic law since 1967, and it

> 8 Figures and trends in this paragraph drawn from: World Bank (October 2022), World Bank (2022a), Palestinian Central Bureau of Statistics (PCBS) (2018), PCBS (2011), PCBS (2007), PCBS (2006), PCBS (2004).

6
is isolated from the remainder of the West Bank by the separation barrier and expanding settlements.<sup>9</sup> The West Bank does not function as a single contiguous administrative system. The Oslo Accords designated discontinuous areas to be assigned to the civil and security (or joint security) jurisdiction of the PA—Areas A and B—and left the more than 60 percent of the territory remaining primarily under Israeli control as Area C.<sup>10</sup> The PA is responsible for service provision in Area C, but infrastructure development and taxation fall within Israeli authority.<sup>11</sup> Gaza meanwhile is under a sea and air blockade, and has been under the _de facto_ authority of Hamas since 2007. The PA and the _de facto_ authorities in Gaza do not coordinate administrative and fiscal systems.<sup>12</sup> Palestinians living in these distinct contexts experience very different fiscal and socioeconomic realities, and it is difficult to move between the physically separated territories.<sup>13</sup>

## **The PA operates within the policy constraints defined by this fragmentation and by the Paris Protocol.**

Intended as a temporary arrangement, over 25 years after its signing the Protocol remains the general framework governing, shaping, and constraining Palestinian trade relations, and trade, macroeconomic, and fiscal policies, including economic and fiscal relations between the PA and the Government of Israel (GOI).<sup>14</sup> Among other provisions, it ties Palestinian regulatory frameworks, indirect tax rates, and trade policy to those of Israel.<sup>15</sup> It also established the revenue clearance system by which the GoI is supposed to collect and transfer certain public revenues to the PA, including import taxes, taxes on Palestinian workers in Israeli-administered territories, and taxes on economic activity in Area C.<sup>16</sup> Some provisions of the Paris Protocol are outdated, and sometimes inconsistently implemented. In addition, under the current _de facto_ authority Gaza is not integrated into the Protocol. The fiscal difficulties this situation creates for the PA are substantial: the administration spent about one-third of its 2021 budget in East Jerusalem and Gaza but collects almost no revenue from these areas or from Area C.<sup>17</sup>

## **Acknowledging these constraints, this analysis aims to understand the distributional impacts of PA fiscal**

**policies.** We aim to analyze the overall household welfare effects of a complex fiscal environment and identify areas where policy change could reduce poverty and advance equity.

# **1.1 Six Key Findings**

**1. Fiscal policies reduce inequality but increase poverty.** The final model in the analysis finds that the combination of taxes and public transfers in the 2017 fiscal year reduces inequality by 6.5 Gini points and increases the national poverty headcount by 8.4 percentage points. Much of the reduction in inequality is driven by in-kind benefits (basic public education and public health), while the poverty increase stems from the fact that the social protection system in the West Bank and Gaza is too small to compensate for the impoverishing effects of indirect taxes such as customs duties and the Value-Added Tax (VAT). The

> 9 United Nations General Assembly (September 14, 2022).

> 10 United Nations General Assembly (September 14, 2022).

> 11 United Nations General Assembly (September 14, 2022); United Nations Conference on Trade and Development (2019).

> 12 Office of the United Nations Special Coordinator for the Middle East peace process (September 22, 2022).

> 13 See for example World Bank (September 2022); United Nations Office for the Coordination of Humanitarian Affairs (OCHA) (January 25, 2023), OCHA (January 23, 2023), OCHA: occupied Palestinian territory (OCHA oPt) (June 2020).

> 14 Office of the United Nations Special Coordinator for the Middle East peace process (September 22, 2022).

> 15 World Bank (September 2022), Office of the United Nations Special Coordinator for the Middle East peace process (September 22, 2022).

> 16 World Bank (September 2022), United Nations Conference on Trade and Development (2019).

> 17 International Monetary Fund (2022b).

7
reduction in inequality also reflects substantial redistribution from the West Bank to Gaza, as the model assumes that residents of Gaza pay few taxes but benefit more from public transfers.

**2. Nationally, most fiscal interventions are progressive relative to Market Income.** This means that the rich pay a larger share of total taxes than their share of market income, and the poor receive a larger share of total transfers than their market income share. The exceptions are fuel subsidies, pension income, and property tax on land which are all regressive.

**3. While indirect taxes reduce inequality in the West Bank and Gaza, they nevertheless constitute a burden for the poor and so require compensation.** Given that the poor tend to consume more from informal retail outlets, indirect taxes like the VAT become _de facto_ progressive (Bachas et al. 2020). The large size of VAT and its progressivity reduces inequality through greater taxation of the rich as a share of income. Nonetheless, indirect taxes like the VAT still constitute a burden for the poor that increases poverty, which should be compensated for in the form of greater social protection.

**4. To reduce poverty, more redistribution to deciles 2 and 3 needs to occur.** At the national level, only the poorest decile is a net cash beneficiary of the fiscal system; that is, they receive more from the system in the form of direct transfers and indirect subsidies than they pay in the form of direct taxes, pension contributions, and indirect taxes. All the remaining deciles are net payers to the fiscal system. The fact that deciles 2 and 3 are net payers is consistent with the increase in the national poverty headcount due to fiscal policy, and that the richest decile has a larger net cash loss is consistent with inequality reduction.

**Expanding targeted social protection cash transfers to offset the tax burden would reduce the povertyincreasing effects of the fiscal system.** Including the Cash Transfer Program (CTP)<sup>18</sup> reduces poverty by 2.2 percentage points, more than any other instrument, and only pension income benefits come close to this at 2.0 percentage points. While the first three deciles live below the poverty line, only 26 percent of total transfers (pensions, direct transfers and indirect subsidies) currently go to the first decile, with decile 2 receiving 8 percent and decile 3 receiving 5 percent.<sup>19</sup>

# **5. Indirect electricity and fuel subsidies are an inefficient way of compensating the poor, hence they**

**should be rationalized to generate fiscal space and expand more redistributive social programs.** In absolute terms, the rich benefit more from electricity subsidies than the poor, although they are progressive. Changing the consumer tariff structure from incremental block tariff to volumetric could increase the progressivity of the electricity subsidies and enhance their redistributive effect, although an untargeted subsidy will never be as effective as a targeted cash transfer. Fuel subsidies are regressive, benefitting the rich more than the poor both in absolute and relative terms. Reducing the size of fuel subsidies in favor of a targeted cash transfer would represent a greater benefit to the poor.

# **6. Given the relatively flat structure of the Personal Income Tax, it is only slightly more progressive than**

**the VAT (measured by a Kakwani Index of 14.1 and 12.6 respectively).** Revising the structure of the PIT to increase the number of brackets, and implementing a more progressive set of rates would increase the progressivity of the tax, and the overall impact on inequality-reduction.

> 18 Fiscal instrument refers to the ensemble of taxes and transfers which a government has at its disposal for redistribution and other objectives.

> 19 If we exclude pension income, then 59 percent of direct transfers go to the first decile, 10 percent go to the second decile, and 7 percent to the decile 3.

8
The rest of this report is organized as follows: Section 2 describes the fiscal system in the West Bank and Gaza, providing context on each of the fiscal instruments modeled in this assessment and an overview of the share of taxes and revenues modeled. Section 3 describes the fiscal administrative and microdata sources used for our model and the Commitment to Equity (CEQ) framework used in the analysis. Section 4 describes methodologies used to allocate each of the fiscal instruments, while Section 5 analyzes headline results. Section 6 presents the marginal contribution from each fiscal intervention to poverty and equity, while Section 7 presents distributional analysis by decile. Section 8 analyzes how fiscal interventions in the West Bank and Gaza compare to other countries in terms of distributional effects. Section 9 provides macro-validation, totals allocated in the survey compared with the official fiscal administrative data and reflects on the main limitations of the analysis. Finally, Section 10 provides concluding remarks.

9
# **2 Tax revenue and public expenditure**

## **This section provides an overview of tax and public expenditure instruments in the West Bank and Gaza.**

This report assesses 89 percent of all tax revenue the PA collects and 42 percent of primary government expenditures.

- **2.1 Overview of the fiscal system**

## **Table 2-1 shows the disaggregation of tax revenue and government expenditure for the West Bank and Gaza in 2017, based on official government sources.**

## **Tax revenue represents 20.7 percent of GDP in 2017, and this report models around 89 percent of this**

**(equivalent to 18.5 percent of GDP).** About 19 percent of GDP stems from indirect taxes levied on consumption, production, and trade activities, while direct taxes represent 1.7 percent of GDP.  Indirect tax collections stem mostly from taxes on international trade (7.1 percent of GDP), followed by VAT (5.9 percent of GDP), and excises (5.2 percent of GDP). Within direct taxes, Corporate Income Tax (CIT) represents the largest source of revenues (0.9 percent of GDP), followed by payroll taxes (0.4 percent of GDP), and the PIT (0.3 percent of GDP). We model 95.8 percent of indirect taxes (VAT, customs duties, and excises)—omitting only taxes on use of goods, and permissions—but only 18.3 percent of direct taxes (PIT and property tax). The small share of direct taxes modeled is mainly due to the inability of a CEQ assessment to measure CIT.<sup>20</sup>

## **Total primary government expenditure is 27.4 percent of GDP in 2017, and we model 42 percent of that**

**(to the value of 11.6 percent of GDP).** Social expenditure is 14.1 percent of GDP, while non-social government expenditure represents 13.3 percent of GDP. We model 81 percent of social expenditures and about 1.5 percent of non-social government expenditure by including the indirect subsidies on electricity and fuel. The main government social expenditure categories included in this study are education (5.0 percent of GDP), social protection (4.5 percent of GDP) and health (3.9 percent of GDP). We model 79 percent of education expenditures, 92 percent of social protection expenditures, and 84 percent of health expenditures. According to available information, indirect subsidies reached only 0.2 percent of GDP (Table 2-1). Most of the non-social expenditure stems from public order and safety (7.3 percent of GDP) and general public services (4.4 percent of GDP excluding debt transactions), which are not included in the current fiscal incidence model. The latter categories are all public goods for which the CEQ framework has no standard methodology for allocation. (See Box 3.2 on caveats and limitations of the methodology).

## **Table 2-1 Total revenue and government expenditure in the West Bank and Gaza in 2017 is 27.0 and 27.4 percent, respectively, of GDP**

Total revenue and government expenditure, West Bank and Gaza (2017)

|**Year of Budget Data: 2017**|**W**|**est Bank and**|**Gaza**|
|---|---|---|---|
|**Government Revenue & Expenditure**<br>**(Million NIS, unless otherwise specified)**|Total (%<br>of GDP)|Included<br>(Yes/No)|Total<br>included as<br>% of GDP|

> 20 The CIT is better modelled with tax administrative data. Also, it is a challenge to distribute CIT burdens across households.

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|**Total Revenue & Grants**|27.0%|||
|---|---|---|---|
|Revenue|22.5%||18.5%|
|Tax Revenue|20.7%||18.5%|
|Direct taxes of which|1.7%||0.3%|
|Taxes on income, profits and capital gains, of which:|1.2%|Partial|0.3%|
|Corporate Income Tax|0.9%|No|0.0%|
|Personal Income Tax|0.3%|Yes|0.3%|
|Taxes on payroll and workforce|0.4%|No|0.0%|
|Taxes on property|0.0%|Yes|0.0%|
|Total Contributions to Social Insurance|1.4%|Yes|1.4%|
|Indirect Taxes of which:|19.0%||18.2%|
|General Tax on goods and services (VAT)|5.9%|Yes|5.9%|
|Excise|5.2%|No|0.0%|
|Taxes on international trade and import duties|7.1%|Yes|7.1%|
|Taxes on other goods, permissions|0.8%|No||
|**Primary Government Expenditure**|27.4%||11.6%|
|Social Expenditure|14.1%|Partial|11.4%|
|Social Assistance of which:|4.5%|Yes|2.8%|
|Family and children|0.0%|n/a|n/a|
|Social protection n.e.c.|4.5%|Yes|2.7%|
|Social contributions (employee benefits)|1.8%|Partial|1.4%|
|Education of which:|5.0%|Partial|4.0%|
|Basic|2.2%|Yes|2.2%|
|Secondary|1.7%|Yes|1.7%|
|Health of which:|3.9%|Partial|3.3%|
|Primary healthcare facilities|0.8%|Yes|0.8%|
|Hospital healthcare facilities|2.5%|Yes|2.5%|
|Non-Social Expenditure, of which:|13.3%||0.2%|
|Subsidies*|0.2%|Yes|Less than<br>0.2%**|

Source: Tax revenue from PCBS. Government Financial Statistics for 2017 prepared by the Ministry of Finance. For further disaggregation, data was supplemented with reports from the Ministry of Education (for education expenditure disaggregation) and National Health Accounts (for health disaggregation).

* Disaggregation for fuel and water subsidies is not available in the Government Financial Statistics and amounts in other technical documents included both explicit and implicit subsidies therefore it is not included here, but instead used in the macro-validation section.

** We cannot estimate the proportion of the total subsidy amount that we cover given that we do not know the share of total subsidies allocated to types of subsidies such as non-fuel and electricity subsidies, water.

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# **2.2 Pensions**

**There are three different pension schemes in the Palestinian Territories: the unified pension scheme, the Gaza civil servant pension scheme, and the West Bank civil servant pension scheme; there is one scheme for those contributing to the Israeli pension system** (see Table 2-2). The pension system in the West Bank and Gaza is being unified through Public Pension Law No.7 of 2005, which covers public servants, security forces agents and personnel, employees of local authorities and other public institutions, Non-Governmental Organization (NGO) workers, and private sector employees. The most recent amendment is Presidential Decree No.5 of 2007, which made the pension system mandatory for private sector workers. The Palestine Pension Authority (PPA) administers the pension system, with the size of the contribution and benefits varying depending on whether the employee is subscribed to the new unified system or to the local system for civil servants in the West Bank and Gaza.

**The unified public pension scheme covers six main categories of beneficiaries:** (i) civil servants paid by the Palestine National Authority (PNA), (ii) security personnel who are less than 45 years old as of 9/1/2006 paid by the PNA, (iii) the broad-based Palestine Liberation Organization (PLO) members paid from the PNA general budget, (iv) local authorities and public institution employees, (v) NGO employees, and (vi) private-sector workers. Contributions to the unified pension system have three main components: a defined benefit (DB) component, a defined contribution (DC) component, and a lumpsum welfare part. The minimum contribution period is 15 years of service. The benefits are disbursed as a lifetime pension following retirement. The legal age for retirement is 60 years old, but early retirement is authorized at 55 years old for men and 50 for women, provided a minimum of 15 years of service has been met.

**In addition to the unified pension scheme, two separate pension schemes apply to civil servants in the West Bank and Gaza who were 45 years of age or older in 2006.** The Gaza civil servant pension scheme covers all the below categories of people older than age 45 as of 09/01/2006: (i) Gaza civil servants, (ii) Gaza municipality employees, (iii) Village councils’ employees, (iv) employees of the electricity distribution company in Gaza, and (v) civil servants working in the West Bank appointed after 2000 by decree of President Yasser Arafat.  The legal age for retirement under this scheme is 60 with at least 15 years of active service. Early retirement is allowed with at least 20 years of service and subject to a pro-rated deduction in the pension until the age of 60. The West Bank civil servant pension scheme covers public servants who were appointed before the year 2000 to the service in the West Bank and are older than age 45 as of 09/01/2006.

**The National Insurance Law, first introduced in 1953, governs the Israeli state pension, which comprises a universal insurance pension combined with means-tested income support.** Mandatory contributions to defined contribution pension funds were introduced in January 2008. (OECD, n.d.).  The National Insurance Institute administers the pension system, which collects contributions and pays out benefits. A major reform recently enacted has been raising of the retirement age for recipients of old-age allowance from age 65 for men and age 60 for women to 67 for men and 64 for women.

**Table 2-2 There are three pension schemes applicable in the West Bank and Gaza, and one pension scheme for Palestinian employees working in Israel and the settlements**

Summary of pension scheme rates in the West Bank and Gaza, 2017

|**Scheme**<br>**Simulation**|**Total**|**Employee**<br>**Employer**|
|---|---|---|

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|Unified<br>pension<br>system|Eligible and under 55 years of age in 2016.<br>Defined Benefit and Defined Contribution +<br>welfare lump sum of 700 NIS. We only<br>allocate the Defined Benefit and welfare<br>lump-sum, as according to the 2016 Public<br>Expenditure Review (PER). The Defined<br>Contribution proportion is not yet<br>effective.|DB<br>DC|16%<br>6%|7%<br>3%|9%<br>3%|
|---|---|---|---|---|---|
|Gaza civil<br>servant<br>pension<br>scheme|Over 55 years of age in 2016, resident in<br>Gaza & working in the public sector.|22.|5%|10%|12.5%|
|West Bank<br>civil servant<br>pension<br>scheme|Over 55 years of age in 2016, resident in<br>the West Bank & working in the public<br>sector.|2|%|2%|0%|
|Israeli scheme|Allocated to employees only who claim<br>that their employers make pension<br>contributions.|17.|5%|5.5%|12%|

Source: World Bank Public Expenditure Review, 2016.

# **2.3 Tax revenues**

**All taxes are collected by the central government’s Ministry of Finance (MoF).** Local government units do not collect any type of tax, except for “Education Tax or Fees”, and a building tax for operators<sup>21</sup> (90 percent of the tax is distributed to municipalities, and 10 percent is remitted to the national accounts) (Abdelkarim & Jaber, 2018). Two public departments within the MoF are responsible for tax collection (except for property tax, which is collected by the General Administration of Property Tax): the General Administration of Customs and VAT and the General Directorate of Income Tax (GDIT). Collection of tax at source from salaries and wages is a smooth process with relatively few administrative complications; employers deduct the tax directly from employees’ incomes and transfer these to the MoF. Private taxpayers follow the same procedures. Israel collects clearance revenues<sup>22</sup> and customs duties and then transfers them to the PA after deducting amounts owed by the Palestinians for Israeli electricity and water utilities.

## **2.3.1 Direct taxes**

## **Personal income tax (PIT)**

**The applicable tax law (Income Tax Law number 8 of 2011 and its amendments) states that “all realized incomes in Palestine from any source for any person are taxable unless there is a clear tax exemption in the Income Tax Law”.** Palestinian residents and nonresidents are taxed only on income sourced in the Palestinian Territories. West Bank residents pay PIT to the PA, unless they work in Israel, in which case

> 21 A tax building operators pay used to finance infrastructure expenditure on public schools.

> 22 Clearance revenues include import taxes, taxes on Palestinian workers in Israeli-administered territories, and taxes on economic activity in Area C. Source: World Bank (March 2023).

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they first pay the PIT to the GoI and then it is transferred to the PA as part of clearance revenues. East Jerusalem residents pay PIT to the GoI, unless they work in the West Bank, in which case they pay to the PA. Gaza residents do not pay PIT, except for PA workers in Gaza since the tax is deducted at source.

**Taxable income is composed of income from all sources after deducting expenses.** Unless specifically exempt by law, all income is included, less allowable expenses incurred to produce the income and the standard deduction (carryover losses, exemptions, and donations). The individual income tax rate charged is progressive, ranging from 5 to 15 percent (Table 2-3) in the Palestinian Territories and from 1 to 5 percent in Israel. In Israel a 10 percent flat rate is applied to rental income.

**Table 2-3 The income tax framework in the West Bank and Gaza has only three brackets, and**

**statutory rates range between 5 and 15 percent**

Statutory income tax rates for Israel and the Palestinian Territories

|**Israel**||**Palestinian Territ**|**ories**|
|---|---|---|---|
|<br>**Bracket**|**Rate**|**Bracket**|**Rate**|
|1 1 - 62,640|0.1|1 - 75,000|0.05|
|2 62,641 - 107,040|0.14|75,000 - 150,000|0.1|
|3 107,041 - 166,320|0.21|> 150,000|0.15|
|4 166,321 - 237,600|0.31|||
|5 237,601 - 496,920|0.34|||
|6 496,921 - 803,520|0.48|||
|7 > 803,521|0.5|||

Source: Harris Consulting & Tax Ltd. (2017); PWC (2021)

# **Property tax**

**Property tax is collected according to the PA General Administration of Property Tax and then transferred to municipalities.** The Jordanian Property Tax Law no. 11 of 1954 regulates the property tax for properties in the West Bank, while the Property Tax Law in Cities No. 42 of 1940 and the Property Tax Law in Villages, No. 5 of 1942 regulate properties in Gaza. Property tax is imposed on owners of the property or building, both resident and nonresident, and varies for land (unconstructed property) and building. The tax rate varies by municipality and by occupation status of the building (rented, prepared in preparation for rental, and inhabited by the owner). For buildings, property tax is imposed at a rate of 17 percent of the annual rental value of the building after depreciation/lease cost (20 percent of value). The tax on unconstructed buildings is 10 percent of the property valuation, based on the unit value of the land.

# **2.3.2 Indirect taxes**

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## **Customs duties**

**Imports customs regulations and procedures in the Palestinian Territories and Israel are determined within the framework of Israeli customs laws, international customs agreements, and the Paris Protocol signed by the GoI and the Palestinian Liberation Organization (PLO) in 1994.** Valuation of commodities for customs purposes is based upon the 1994 General Agreement on Tariffs and Trade (GATT). The Palestinian customs system is laid out in Customs Law No. 1 of 1962, which specifies its functions, procedures, and transparency and integrity standards.

## **Value-Added Tax (VAT)**

**VAT is levied on the sale of goods, the provision of services, and imports.** The PA does not currently collect any domestic VAT in Gaza. Domestic VAT is only collected in the West Bank. Import VAT—one of the taxes making up clearance revenues that Israel collects on behalf of the PA—is transferred to the PA’s MoF in the West Bank. In 2017 (the year of analysis), the statutory VAT rate was 16 percent. Under the Paris Protocol, The PA VAT rate should be within the range of maximum (minimum) 2 percentage points above (below) the Israeli VAT rate. Regarding preferential VAT, only crop production and commercial transactions carried out by charitable societies and donor organizations are subject to “zero rates”. In 2017 the main VAT exemptions were applied to tourism services (purchases by foreigners), fresh fruit and vegetables, and exports.

## **Excises**

**In the Palestinian territories, excise taxes are applied domestically to a selection of products** . This includes alcoholic beverages, petroleum, vehicles, and tobacco (regular and flavored hookah tobacco).<sup>23</sup> West Bank residents must pay excises to the PA (according to PA rates) for alcoholic beverages and tobacco purchased in the West Bank and for fuel bought by the PA from Israel; also, PA tax rates are applied for imported goods from third countries. East Jerusalem residents pay to the GoI according to the Israeli tax rates for goods imported from third countries or purchased in East Jerusalem; they pay to the PA directly on alcohol and tobacco purchased in the West Bank. In 2017 the Israeli excise rates for the fuel products were 2.89 NIS/L for gasoline, NIS 3.02 NIS/L for diesel and 2.89 NIS/L for kerosene; it is expected that PA excise rates are similar to avoid arbitrage across countries.

# **2.4 Transfers**

## **2.4.1 Direct transfers Social Protection**

**The PA’s Ministry of Social Development (MoSD) is responsible for provision of basic social protection to the most vulnerable families in the West Bank and Gaza through various cash and near cash programs.** There are four main components of social protection programs in the West Bank and Gaza: social assistance, social insurance, social services, and social justice.

**The primary government-funded social protection program is the national Cash Transfer Program (CTP).** In the year 2017, the CTP represented 63 percent of the total MoSD budget.<sup>24</sup> The CTP aims to reach households below the extreme poverty line and marginalized households between the national and

> 23 Import Laws and Procedures, 2022, Investment Promotion and Industrial Estates Agency, <u>Import Laws and Procedures (pipa.ps).</u>

> 24 Annual Statistical Report (2017), Ministry of Social Development.

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extreme poverty lines.<sup>25</sup> Eligibility for the beneficiaries is determined by a Proxy Means Test (PMT) based on household expenditure and consumption data, including 34 variables related to “characteristics of the household head (gender, health, and disability status), marital status (divorced, widowed), household size and composition (children, elderly), employment status, assets (cars, livestock, and property including condition and building materials), and health of household members” (Wong et al 2019, 12). Participating households receive cash transfers quarterly of between NIS 750 and NIS 1,800<sup>26,27</sup> directly into their bank accounts. In addition to the CTP, the MoSD administers a number of other cash assistance programs including cash assistance to orphans and distressed families, cash assistance to discharged government employees, and emergency cash assistance for women. Near-cash social assistance includes food assistance/daily rations to the beneficiaries.

# **2.4.2. Indirect subsidies**

**A fundamental characteristic of the West Bank and Gaza’s energy supply is its reliance on imports, particularly from Israel, Jordan, and the Arab Republic of Egypt.** Almost all fossil fuels are imported.

## **Electricity**

**Residents of the West Bank and Gaza rely on imported electricity, primarily from Israel.** The imported share is about 99 percent of total supply in the West Bank and 64 percent in Gaza.<sup>28</sup> The Palestinian Energy and Natural Resources Authority (PENRA) is responsible for provision of electricity and for energy policy formulation. There are five electricity distribution companies (DISCOs) and a single buyer of electricity, the recently established Palestinian Electricity Transmission Company (PETL). The PETL sources electricity from the Palestine Power Generation Company (PPGC), Israel, and other neighboring countries. In Gaza, the Palestine Electric Company (PEC) operate the Gaza Power Plant at partial capacity.

**The current electricity tariff structure for domestic consumers (Table 2.4) was promulgated in 2017 in Article 5, Ministerial decision N 03/137/17.** It applies in all regions of the Palestinian Territories except for residents of Jericho and the Palestinian Jordan Valley. Access to the electricity is widespread with 98 percent of the PECS survey respondents in all the regions of the Palestinian Territories reporting having access in 2017. Most consumers (approximately 65 percent) consume in slab 2 (161-250 kWh) and slab 3 (251-400 kWh) of the tariff structure.

**Table 2-4 The price of electricity per kWh for domestic consumers ranges between 0.458 and 0.6731 in the West Bank and Gaza**

Price of electricity by consumption slab, West Bank and Gaza

|**Consumption slabs**|**Price**|
|---|---|
|**(kWhper month)**|**(NISper kWh)**|
|1- 160|0.458|

> 25 As of its 2017 Annual Statistical Report, the MoSD (2018) estimated the extreme poverty line at NIS 1,970 per month and the national poverty line at NIS 2,470 per month for a family of two adults and three children, with the specific amount determined by the PMT.

> 26 Ministry of Social Development (Jan 2018); Ministry of Social Affairs (Jan 2017); The Office of the European Union Representative (Oct 2019); The World Bank (Dec 2018).

> 27 The specific amount depends on households PMT score.

> 28 <u>https://www.worldbank.org/en/country/westbankandgaza/brief/securing-energy-for-development-in-west-bank-and-gazabrief</u>

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|161-250|0.4938|
|---|---|
|251- 400|0.5695|
|401-600|0.6089|
|More than 600|0.6731|

Source: Prime Minister’s Office (2017).

**The electricity tariffs are low relative to the cost-of-service provision, leading to subsidies (explicit and**

**implicit) in the sector.** The subsidy to domestic consumers is mainly provided in the form of a Tariff Differential Subsidy (TDS). The regulatory authority, PERC, has set a uniform tariff of NIS 0.53– 0.56 (US$0.14–0.15) per kWh for the Palestinian DISCOs for purchase of electricity. However, financial analysis of the sector suggests that the full cost of service provision—given current inefficiencies—ranges from about NIS 0.66 to NIS 1.42 (US$0.18–0.39) per kWh, depending on the DISCO. The mechanism currently used to safeguard affordability for some consumers is a “Rising Block Tariff or Incremental Block Tariff”, whereby the tariff of the previous slab is granted to all the units consumed up to the lower bound of the slab in which their consumption falls. In the West Bank and Gaza, with the first block of 160 kWh per month currently set at NIS 0.43 (US$0.11) per kWh, matching the lowest income decile’s ability to pay. However, given that average residential electricity consumption in the West Bank and Gaza is only 200– 300 kWh per month, this means that those wealthier Palestinian consuming most of the electricity benefit the most from this subsidized rate.

# **Fuel**

**As for electricity, the Palestinian population relies on fuel imports.** Under the Paris Economic Protocol (PEP), the West Bank and Gaza is allowed to import petroleum from sources other than the Israeli supplier provided that the final consumer price in the Palestinian Territories is less than 15 percent lower than in Israel. The clause further prescribes that Israel shall collect taxes and customs at crossing points.

**The General Directorate of Petroleum (GDoP) is charged with the responsibility of regulating imports of oil and petrochemicals.** The GDoP purchases an average of 80 million liters of fuel a month, including 25 million liters of gasoline, 55 million liters of diesel, and 14,000 tons of cooking gas and other byproducts like kerosene and gas. It is also the monitoring and licensing agency that sets petroleum and petrochemical prices.

**Fuel prices in Israel depend on the world oil price index.** Average prices are calculated monthly based on the last five workdays of the previous month. The GDoP is provided with the Israeli refineries’ costs, profit margin, and the logistic expenses. A deduction is applied for the global gasoline evaporation rate (0.005), and addition of the Blu Tax and VAT taxes.

**Fuel prices in the Palestinian Territories do not fully reflect fluctuations in global oil prices due to the addition of taxes and subsidies, and exchange rate fluctuations with the dollar.** In general, taxes represent an average of 68 percent of total purchase price. Government fuel subsidies on the consumption of petrol, gas, and other fuel products help alleviate price increases for Palestinian consumers. The GDoP calculates fuel prices at the beginning of every month after consultation with the Minister of Finance to determine the size of financial subsidies, which depends on the financial position of the government, liquidity available in the Treasury, and fluctuations in global oil prices.  Retail prices in the West Bank and Gaza are lower than the global price due to the subsidies, on top of which the retailer

17
adds a fixed profit margin. The global price, less the subsidy, plus the retailer’s profit margin determines the final price consumers pay at the pump (Prime Minister’s Office, 2017).

# **2.5 In-kind benefits**

## **Health**

**The Ministry of Health (MoH) is responsible for provision of health services in the West Bank and Gaza.** The Palestinian health system consists of four main sectors including: (i) the government health sector (the Palestinian Ministry of Health and Military Medical Services), (ii) the United Nations Relief and Works Agency (UNRWA), (iii) NGOs, and (iv) the private sector. Primary healthcare provision is shared across the different sectors, while the provision of secondary and tertiary healthcare is led by the government health sector. From the supply side, the government health sector provides about 63 percent of the primary healthcare facilities, while in Gaza most residents tend to access UNRWA health facilities.<sup>29</sup>

**Health care services are provided to citizens at three levels: primary, secondary, and tertiary.** Primary health care is provided by centers classified into four categories based on the combination of preventive and curative services offered, in addition to mobile clinics (Ministry of Health, 2017).

**All residents of Gaza enjoy free health insurance under article (2) of the presidential decree issued on 26/6/2007, while health insurance in the West Bank is for participating families only, although contributions are mainly symbolic.** Health insurance available in the West Bank includes a compulsory health insurance scheme for public sector employees, municipalities, and retirees, as well as other types of health insurance including voluntary insurance, insurance for workers within the Green Line,<sup>30</sup> group insurance, social affairs insurance, and prisoners’ insurance.

## **Education**

**The Ministry of Education and Higher Education (MoEHE) manages public schools, including regulatory overview of private schools.** This includes pre-school, primary (or basic) and secondary school (grades 1 through 12), technical and vocational, non-formal, and higher education. The MoEHE is the official body responsible for running, organizing, and developing the educational sector either through direct management or supervision. It also spearheads the national education strategic planning process. The Schools’ Census 2016-17 showed that there were about 2,963 schools in the Palestinian Territories, 73 percent of them administered by the government, and about 1,229,756 students were enrolled, about 65 percent of them in government schools.

# **2.6 International comparison**

**Tax revenue in the West Bank and Gaza as a share of GDP is high at about 20.7 percent.** This compares to an average of 18.1 percent for all countries included in the CEQ Institute’s data center. It is also high compared to the average of lower middle-income countries of about 17.9 percent of GDP (indicated by the dashed orange line in Figure 2-1).

> 29 While UNRWA’s mandate is to provide services to refuges, its health services are mainly focused on primary health care, and it purchases secondary/tertiary services for a limited number of cases.

> 30 Workers within the Green line refers to individuals working in Israel. The Green Line is the demarcation line set out in the 1949 Armistice Agreements between the armies of Israel and those of its neighbors (Egypt, Jordan, Lebanon and the Syrian Arab Republic) after the 1948 War.

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**Figure 2-1 Tax revenues as a share of GDP are higher than the sample average at 20.7 percent**

<!-- Start of picture text --> International comparability of tax revenue<br>40%<br>West Bank and Gaza<br>35%<br>(2017), 20.7%<br>30%<br>25%<br>20%<br>15%<br>10%<br>5%<br>0%<br>Country (CEQ assessment year of survey)<br>Tax revenue as % of GDP (ranked lowest to highest) Iraq (2018) Mexico (2012) Pakistan(2018) Guatemala (2011) Sri Lanka (2009) Ethiopia Indonesia (2012) Ecuador (2011) Paraguay (2014) Costa Rica (2010) Ghana (2012) Honduras (2011) Burkina Faso (2014) Russia (2010) El Salvador (2011) Colombia (2014) Peru (2009) Peru (2011) Chile (2013) Armenia (2011) Lesotho (2017) China (2014) El Salvador (2015) Tunisia (2010) South Africa (2015) Argentina (2012) Turkey (2014) Georgia (2013) United States (2016) Romania (2016) Bolivia (2009) South Africa (2010) Namibia (2016) Tajikistan (2015)<br>Dominican Republic (2013) West Bank and Gaza (2017)<br><!-- End of picture text --> Source: CEQ Data Center, Government Finance Statistics Manual West Bank and Gaza

**West Bank and Gaza’s social expenditure as a share of GDP is also a high 14.1 percent.** This compares to the average among both lower middle-income countries (9.4 percent) and upper middle-income countries (11.5 percent) in the sample of countries included in CEQ Institute’s Data Center.<sup>31</sup> It is also high compared to the average of 10.3 percent of all countries in the CEQ data center sample (indicated by the dashed red line in Figure 2-2).

> 31 CEQ Data Center on Fiscal Redistribution (https://commitmentoequity.org/datacenter) accessed June 2023.

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**Figure 2-2 Social expenditures as a share of GDP are higher than the sample average at 14.1 percent**

<!-- Start of picture text --> International comparability of government social expenditure<br>25%<br>West Bank and Gaza<br>(2017), 14.1%<br>20%<br>15%<br>10%<br>5%<br>0%<br>Country (CEQ assessment year of survey)<br>Ivory Coast (2015) Iran (2011) Uganda (2016) Indonesia (2012) Guatemala (2014) Albania (2015) Ethiopia Tanzania (2011) Iraq (2018) Togo (2015) Ghana (2012) Armenia (2011) Egypt (2015) Tunisia (2010) Mexico (2014) Colombia (2010) El Salvador (2011) Paraguay (2014) Ecuador (2011) El Salvador (2013) Romania (2016) Mexico (2010) Chile (2013) Honduras (2011) South Africa (2015) Georgia (2013) Croatia (2014) Venezuela (2013) Belarus (2015) Bolivia (2009) Russia (2010) Brazil (2009) Lesotho (2017) Argentina (2012) Botswana (2010)<br>Social expenditure as % of GDP (ranked lowest to highest)<br>West Bank and Gaza (2017)<br><!-- End of picture text --> Source: CEQ Data Center, Government Finance Statistics Manual West Bank and Gaza.

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# **3 Data and methodology**

### **The objective of this fiscal incidence analysis is to analyze the impact of taxes and social expenditure on**

**households’ welfare, poverty, and inequality in the West Bank and Gaza.** Although designing and implementing fiscal policies should consider different dimensions—including fiscal sustainability, economic efficiency, externalities, and equity—the motivation for performing our analysis is fourfold:

- (i) There has not been a comprehensive distributional assessment of the country’s fiscal system.

- (ii) The current government is operating in an environment of increasing fiscal pressure, with an urgent need to mobilize revenue and increase fiscal space.

- (iii) Given the above, findings from the fiscal incidence analysis create an evidence base for how to promote tax and expenditure reforms consistent with both fiscal sustainability and fiscal equity.

- (iv) In addition to helping assess distributional repercussions of existing fiscal policies, developing detailed microsimulation models for fiscal incidence analysis also creates a platform to simulate distributional impact of potential policy reforms.

## **3.1 Data sources**

### **The fiscal incidence analysis in the Palestinian Territories uses the following data sources:**

- The most recent, nationally representative household survey, the Palestinian Expenditure and Consumption Survey (PECS) 2016/17, is a multi-purpose survey on household budget and living standards used to estimate official poverty statistics for the Palestinian Territories. PECS was implemented by the Palestinian Central Bureau of Statistics (PCBS). The PECS 2016/2017 is a 12month survey covering 3739 households and implemented from October 2016 to September 2017. The survey has information on income, employment, consumption, health, and education.

- Tax legislation and comprehensive administrative data on direct and indirect taxes, tax rates, tax collection, and executed government expenditure data from MoF and World Bank teams.

- Social protection data from the main social programs on budget, beneficiaries, and allocation rules from the MoSD and the World Bank Social Protection team.

- Data to calculate the subsidy value for domestic electricity distribution and fuel from the Ministry of Energy and the World Bank Energy team.

- Education expenditures and student enrollment from the Ministry of Education and World Bank Education team.

- Health expenditure and health visits from the Ministry of Health and the World Bank Health team

- Supply and use tables from 2017 for the West Bank and Gaza from the World Bank Macroeconomics, Trade, and Investment team.

- The 2017 Labor Force Survey (LFS) on labor informality and public sector employees, also implemented by the PCBS.

## **3.2 Commitment to Equity (CEQ) framework**

### **This study uses the Commitment to Equity (CEQ) methodology to implement a fiscal incidence analysis**

**of the main taxes and public social transfers of the West Bank and Gaza in 2017** . A CEQ Assessment is a rigorous and standardized fiscal incidence methodology that permits systematic analysis of how different tax and public expenditure options affect the welfare distribution. CEQ uses a common framework

21
developed by the CEQ Institute and presented in the CEQ Handbook (Lustig, 2022). CEQ Assessments have been implemented in over 60 countries at the time of writing this report.

# **The first step of fiscal incidence analysis is allocation of the main taxes and transfers to households in**

**the survey.** The main modeling techniques in this report include direct identification, inference, imputation, simulation, and prediction. These concepts are described in Box 3.1, below. Typically, fiscal interventions such as direct taxes, indirect taxes, and indirect subsidies are modeled based on simulation, combining tax rules and characteristics of individual’s employment and consumption patterns, respectively.

**Box 3.1: Tax and transfer allocation methods**

<mark>We allocate each tax and transfer by drawing from a set of methods described in detail in Chapter</mark> 3 of the CEQ Handbook, namely:

- **Direct identification:** The survey asks whether a tax (transfer) was paid (received), and the amount.

- **Inference:** Whether a tax (transfer) was paid (received), or the amount, is determined based on administrative data of the taxes (transfers) and other relevant secondary information self-reported by the household.

- **Imputation:** Taxpayers (beneficiaries) are directly identified in the survey, but the amount of a tax (subsidy) paid (received) is imputed based on program rules.

- **Simulation:** Both the identification of taxpayers (beneficiaries) and the amount of a tax (subsidy) paid (received), is estimated based on program rules.

- **Prediction:** A regression model is applied to predict who receives benefits or pays taxes, and/or the amount.

Adapted from Chapter 3 of Lustig (2022).

**The building block of fiscal incidence analysis is the construction of income concepts.** Conceptually, the analysis starts from a household’s pre-fiscal income<sup>32</sup> —that is, any private income that excludes any government intervention—and each new income concept is constructed by including different layers of the fiscal system, or categories of taxes and transfers, as shown in Figure 3-1, until a household’s total post-fiscal income is estimated (income once all taxes and transfers are included).

**Once completed, we can estimate the distributional impacts of any tax or transfer decisions on the welfare of a country’s households** . Once all fiscal instruments and income concepts are constructed, the analysis measures the main distributional repercussions, such as changes in number of households living under the poverty line, identification of groups which are net cash-beneficiaries, and impact of any tax and/or government’s transfers on inequality and progressivity, as well as the marginal contribution of each fiscal intervention to poverty and inequality reduction.

> 32 Pre-fiscal income could be equivalent to Market Income or Market Income plus pensions depending on the pension scenario chosen for the baseline. This is explained in more detail later in this section.

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**In countries where consumption is a more reliable measure of welfare than income (as in the West Bank and Gaza), the analysis starts by setting Disposable Income equal to the consumption welfare aggregate and adds or removes certain fiscal interventions to calculate the other income concepts.** Given that Disposable Income already includes certain interventions of the fiscal system, the analysis can move “backwards” to remove fiscal interventions until reaching “pre-fiscal income”, a measure of households’ total income from private sources only. Also, the analysis works “forwards” from Disposable income, adding additional fiscal interventions until reaching “post-fiscal income” (income once all taxes and transfers modeled here have been included). Figure 3-1 displays the different steps of the income construction process.

**The analysis applies this framework to the West Bank & Gaza’s fiscal system as follows:** Net Market Income is calculated from Disposable Income by removing direct social protection transfers (government cash aid and government near-cash aid). Market Income plus pensions is constructed by adding direct taxes (PIT, property tax, and payroll tax) back into Net Market Income. Market Income is calculated from Market Income plus pensions by subtracting pension income and adding pension contributions. The analysis then constructs the rest of the income concepts forward. Consumable Income is constructed by subtracting indirect taxes (the direct and indirect effects of VAT and fuel excises, and the direct effects of customs duties) from Disposable Income and by adding indirect subsidies (the direct effects of electricity subsidies and the direct and indirect effects of fuel subsidies). Lastly, Final Income is constructed by adding in-kind benefits from public education and public health to Consumable Income.<sup>33</sup>

**In the case of the West Bank and Gaza, this fiscal incidence analysis uses the “Pensions as Government Transfer” (PGT) scenario from the CEQ framework.** As the name suggests, in this scenario pensions are treated as a government transfer—a tool for redistribution from one segment of society to another. In the PGT scenario, the pre-fiscal income concept is Market income.<sup>34</sup> The alternative to the PGT scenario is the “Pensions as Deferred Income” (PDI) scenario, in which pensions are treated as private income that is saved. In this scenario, the pre-fiscal income concept is Market Income plus pensions (see results under PDI scenario in Annex A).

**Finally, we consider different post-fiscal income concepts for calculating the impact of fiscal interventions on poverty and inequality.** For calculating total effect on _inequality_ reduction, the postfiscal income is the Final Income concept shown in Figure 3-1—that is, the total effect is the difference in - inequality levels between Market Income and Final Income. However, when calculating total _poverty_ reduction, the post-fiscal income is the Consumable Income concept shown in Figure 3-1 (that is, the total effect is the difference in the poverty rate between Market Income and Consumable Income). The reason for this is that in-kind health and education benefits are allocated at the average government cost of provision, which provides little information about how the transfers improve a household’s purchasing power or their poverty status. Education benefits, for example, will accrue in terms of future purchasing power but the CEQ Framework is limited to measuring distributional effects at a specific point-in-time (see Box 3.2 on CEQ caveats).

> 33 These benefits are modeled as the average government cost of education and health services. The model does not include user fees nor subtract the incidence of user-fees from Final Income.

> 34 As a result, we subtract pension income from Disposable income along with the direct transfers to get to Net Market Income, and we add pension contributions with the direct taxes to reach Market Income.

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# **Figure 3-1 Income concepts in the CEQ framework**

CEQ Income Concepts in the Palestinian Territories; Pensions as a Government Transfer scenario <!-- Start of picture text -->
- Direct transfers<br>Government cash<br>and in-kind, and<br>pensions<br><!-- End of picture text -->

<!-- Start of picture text --> + Indirect subsidies<br>Electricity and Fuel<br>subsidies<br><!-- End of picture text --> <!-- Start of picture text --> + In-kind transfers<br>Education & Health<br><!-- End of picture text --> <!-- Start of picture text --> Final income<br><!-- End of picture text --> <!-- Start of picture text --> Market income<br><!-- End of picture text --> <!-- Start of picture text --> Disposable income<br>Official<br>consumption<br>expenditure from<br>the PECS 2016/17<br><!-- End of picture text --> <!-- Start of picture text --> Net market income<br><!-- End of picture text --> <!-- Start of picture text --> Consumable<br>income<br><!-- End of picture text --> <!-- Start of picture text --> + Direct taxes<br>Personal Income Tax, Pension<br>Contributions, Property Tax<br><!-- End of picture text --> <!-- Start of picture text -->
- Indirect taxes<br>VAT, Customs, Excise<br><!-- End of picture text -->

Source: Adapted from Lustig (2022)

# **Box 3.2 A CEQ Assessment should be interpreted with several important caveats in mind**

CEQ Assessment Caveats

- a) **A CEQ assessment excludes important tax and public expenditure categories** , such as corporate income taxes (an important share of government revenues), and expenditure on infrastructure, defense, and other public goods because of data limitations and because there is no generally accepted methodology for assigning these benefits or burdens to any single individual or household.

- b) **A CEQ assessment considers only the** **_redistributive_ effects of taxes and transfers,** which represent only one of many criteria to take into account when making public policy. A CEQ Assessment does not attempt to assess the sustainability of taxes and transfers from the macroeconomic, demographic, or natural capital perspectives, nor effects on future inequality, poverty, or vulnerability from fiscal policies that increase current economic growth. Results therefore should be weighed against other evidence before deciding whether a specific tax or transfer is desirable or is in need of reform.

- c) **The fiscal incidence analysis used in CEQ assessments is an accounting framework and is point-in-time.** It is a first-order approximation and does not incorporate behavioral or general equilibrium effects. This limits the framework in important ways:

- CEQ Assessment results cannot inform the trade-offs between public expenditure to alleviate present poverty against investments in physical and human capital (through health

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<mark>and education expenditures, for example) with large effects on future well-being through</mark> higher economic growth.

- CEQ Assessments cannot measure the redistributive role of pensions in an intertemporal framework, which is important to accurately estimate the true redistributive effects of pensions.

- The CEQ Assessment framework ignores behavioral responses that taxes and transfers trigger and which may imply important trade-offs in terms of efficiency, effectiveness, and sustainability of the fiscal redistribution compact.

- d) **In-kind benefits from free government education and health services are valued at the average cost of provision.** This does not provide an estimate of the value of these services, nor of the change in purchasing power due to accessing these services. Given that in-kind services cannot be “eaten” or traded, a CEQ analysis does not typically attempt to treat in-kind benefits as additional income in cash terms.

- e) **A CEQ Assessment is based on household survey data** , which typically underrepresent wealthier households.

- Adapted from Lustig <u>(2022).</u>

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# **4 Methodologies for allocating taxes and transfers**

### **This section describes in detail the allocation methodologies used to model each tax and transfer included in the analysis.**

## **4.1 Pensions**

**A CEQ Assessment has two scenarios for treating pensions.** The first scenario treats pensions as saved private income (in the form of contributions) spent later in the form of Pensions as Deferred Income (PDI). The second scenario treats Pensions as Government Transfer (PGT), a tool for redistribution from one segment of society to another by taxing individuals through pension contributions and transferring benefits through pension income.<sup>35</sup> Both scenarios present extremes and reality is always some combination of the two (see Annex A for comparison).

**This analysis uses the (PGT) as the main scenario.** The reason is that pension expenditures are high and unsustainable in the West Bank and Gaza, with pension contributions funding roughly 45 percent of pension payouts, meaning that the Palestinian pension system redistributes from tax-paying individuals to pension recipients. Nonetheless, treating pensions solely as a government transfer means that those earning a comfortable pension will appear to have zero Market Income, thus overestimating the proportion of the poor (Lustig, 2022).

**The pensions model has two components: (i) pension contributions from the current working population, and (ii) pension income received by the retired population.** For this study, the PECS survey directly identifies pension income recipients and amounts. The survey also directly identifies individuals that make pension contributions, and the amounts are inferred based on the region, public sector status and age. A key assumption of the CEQ Assessment is that employer contributions to pensions are borne by the employee in the form of lower wages—that is, the analysis allocates the total pension rate to employees, including both employee and employer’s contributions. The survey identifies roughly 140,000 pension contributors tax resident in the West Bank and Gaza - close to the numbers reported in the latest administrative data of 155,000 contributors.<sup>36</sup>

**There are three major pension schemes in the West Bank and Gaza, and one in Israel.** In the West Bank and Gaza the unified pension scheme applies to individuals below the age of 55 as of 2016, while the Gaza civil servant pension scheme and the West Bank civil servant pension scheme variously apply to pension contributors that were above age 55 in 2016 (the former in Gaza and the latter in the West Bank). All pension contributors in the survey were below age 55 and so the unified pension scheme was applied to all directly identified pension contributors working in the West Bank and Gaza in the PECS 2015/16.<sup>37</sup> There are three components: (i) a defined benefit component (9 percent paid by employer and 7 percent

> 35 Pensions can result in different types of redistribution. They can redistribute within the contributing population, for example by placing a floor and a cap on pension income, they can generate inter-distributional redistribution based on demographics and economic growth, they redistribute from workers who contribute but not enough to receive the benefits, and when the social security system is in a deficit, as is the case in the Palestinian Territories, they redistribute from tax-paying individuals to pension recipients.

> 36 World Bank (2016). Public Expenditure Review of the Palestinian Authority: Towards Enhanced Public Finance Management and Improved Fiscal Sustainability. World Bank Report No: ACS18454. [http://hdl.handle.net/10986/25100]. Administrative data of pension contributors from the Public Expenditure Review (PER) for 2014 (the closest year available).

> 37 According to the program rules, the scheme applies to anyone working in the public sector, a local authority, an International Organization (IO), the United Nations Relief and Works Agency (UNRWA), or a non-Governmental Organization (NGO).

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paid by employee), (ii) a defined contribution component (3 percent paid by both the employer and employee), and (iii) a lump sum “welfare” payment of 700 NIS.<sup>38</sup> For pension contributors that are tax resident in Israel (5,750 pension contributors), a rate of 5.5 percent is applied for workers, and 12 percent for employers.

# **4.2 Direct transfers**

**The PECS 2016/2017 directly identifies cash transfers and near-cash**<sup>**39**</sup> **transfers from social protection.** The survey disaggregates transfers households received from the government (cash vs in-kind) but does not differentiate between types of cash transfer received. The unconditional Cash Transfer Program (CTP) was the main government-funded social protection program in 2016-17, covering households in both the West Bank and Gaza and representing about 63 percent of the Ministry of Social Development’s (MoSD) total budget.<sup>40</sup> According to MoSD’s 2017 Annual Statistical Report, CTP provided benefits to roughly 110,000 households in 2017 (72,000 in Gaza and 38,000 in the West Bank), constituting 687,000 individuals (493,000 in Gaza and 195,000 in the West Bank).  The CTP identifies beneficiaries using a Proxy Means Test Formula (PMTF), which sorts households into categories relative to the extreme and national poverty lines. The exact PMT formula and threshold being used by the government to identify beneficiaries of the CTP was not available for inclusion in the model, and we approximated coverage through a combination of the location of the household and the average monthly transfer amounts to match the administrative data. For the social protection in-kind transfers, all households reported as receiving this transfer from the government have been directly identified and included.

# **4.3 Direct taxes**

## _4.3.1 Personal income tax (PIT)_

**As with the pension contributions, rates for the West Bank and Gaza are applied to those working in the West Bank and Gaza and subject to tax by the PA (in Gaza this includes only PA employees), and Israeli income tax rates are applied to the West Bank and Gaza population working in East Jerusalem, Israel, or the settlements.** Personal Income Taxes paid are simulated by applying statutory rates to formal, tax-liable workers’ self-reported income). Formal workers are restricted to workers of working age, not an unregistered refugee, and that report making pension contributions on their behalf. They are treated as tax liable if they are tax resident in the West Bank and Gaza or Israel (i.e., not working abroad or for a foreign government) and exempt if they have a disability that has a difficulty level of 50 percent of more. The simulation is effective – 109,200 taxpayers are identified in the survey compared to 112,500 in the administrative data.

**Taxable income:** For employees, income is assumed to be net of tax while for employers and selfemployed workers it is assumed to be gross of tax. We observe income in the survey from wages and

> 38 The modeling proceeds under the assumption that the payment is annual.

> 39 Note that while these are described in the PECS 2016/2017 as in-kind transfers, in this assessment they are referred to as near-cash transfers. This is in keeping with CEQ terminology which distinguishes between in-kind transfers such as public health and education services - which are valued at an average cost of provision - and near-cash transfers, such as school feeding or fertilizer - which are valued according to the change in a households’ purchasing power due to the receipt of a good or service.

> 40 The total amount transferred to households through the CTP in 2017 was 518.4 billion NIS in 2017.

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employer income, self-employment income, retirement income, rental income, land, transport, and stocks.

**A residential deduction is allocated to all West Bank and Gaza resident taxpayers, and additional deductions are allocated to those eligible due to expenditures on donations, education, housing, fixed transportation, and pension contributions, in that order.** We do not have information on the order in which these deductions are applied by law, and so they are allocated from largest to smallest (in terms of the average size amongst those that are eligible for the deduction, prior to scaling). Given other administrative and survey data gaps discussed in Annex B deductions cannot be precisely allocated and scaling is applied to compensate for these data gaps. This prevents a substantial over-allocation of these deductions, which would result in an under-allocation of PIT in the survey. Table 4-1 shows the difference in the allocated deduction amount in the survey prior to, and post, scaling, and compared with the administrative numbers. See Annex B for a discussion of the data gaps faced in allocating the deductions.

**Table 4-1: Scaling is applied to deductions to prevent an under-allocation of PIT in the survey**

|**Deduction**|**Survey**<br>**(pre-scaling)**|**Admin**|**Survey**<br>**(post-scaling)**|
|---|---|---|---|
|Residential(billion NIS)|7.1|1.1|1|
|Donations(million NIS)|46.4|n/a|46.4|
|Education(million NIS)|219|6.7|6.02|
|Housing (thousand NIS)|12,411.3|372|346.6|
|Fixed transport to work(thousand NIS)|79.8|329.3*|306.8|
|Pension contributions**|368860.5|34|31.8|

Source: World Bank and Ministry of Finance staff.

* Admin number from 2017

** Based on the employee contributions component only.

**Israeli tax policy allows deductions for disabilities, 52 percent of contributions to national health insurance, rental income, disabilities, and two tax credits: a tax credit**<sup>**41**</sup> **that varies by gender, and a tax credit of 35 percent of total contributions to pensions.** The size of the disability exemption varies based on duration; however the PECS 2016/17 does not indicate duration and so the full exemption of 72,720 NIS is applied to all individuals that report having a complete disability. A tax credit of 2.25 credit points (NIS 483 per month) was allocated to men and 2.75 credit points (NIS 591 per month) to women (a tax credit was worth NIS 215 per month in 2017). An additional 0.25 credit points were applied for travel to place of work for all men, and an additional 0.75 credit points for women. Due to data limitations, the following additional credits are not applied: credits for individuals who are supporting a spouse, have a working spouse, are a single parent supporting a child, have completed a degree within the last 2-3 years (depending on the degree), have applied for credit for individuals supporting a parent within an

> 41 Note that a tax credit differs from an exemption in that it is subtracted from an individual’s PIT liability, rather than from their taxable income.

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institution, or are caring for incapacitated persons. The details of the allocation of these deductions are reported in Annex B.

## **_4.3.2. Property tax_**

**The PECS 2016/17 includes self-reported annual rental property value used to estimate property tax, with simulation including the following steps:**

- (i) Used administrative data to identify the cities from which property tax was collected.

- (ii) Used a city identifier from the location module to identify the core set of municipalities in which property taxes are collected in the West Bank and Gaza.

- (iii) Identified owners within the dataset using self-reported status (given that property tax is paid by owners only).

- (iv) Used a self-reported estimated annual rental value variable to estimate the tax on buildings.

- (v) For tax collection on land, we used administrative data on the valuation of land by applying an average per governorate.<sup>42</sup>

- (vi) Estimated property tax on land is by multiplying the tax rate by the area of land and average land valuation (bifurcated by cities).

- (vii) Scaled-down the survey-estimated property tax by applying a scaling factor such that the effective property tax rate in the survey (that is, the size of the property tax relative to households’ consumption) matches administrative data.

# **4.4. Indirect taxes**

**Indirect taxes in the model include customs duties, VAT and excises, which together represented about 92 percent of total tax collections in the West Bank and Gaza in 2017.** These taxes were simulated by applying statutory tax rates to self-reported household expenditure on each product in the PECS 2016/2017.

## **4.4.1. Customs**

**Simulation of customs duties followed these steps:**

- (i) Mapped customs duty rates to PECS 2016/17 consumption items (average duty for those goods mapped to different HS codes).

- (ii) Excluded non-taxable items from the PECS 2016/17 consumption dataset (self-production, gifts). Netted down to observed households’ expenditure.<sup>43</sup>

- (iii) Applied statutory customs duty rates (differentiated by region) to all taxable products.

**The PECS 2016/2017 does not have a variable to identify imported products, so the study assumes the “Law of One Price”—that is, the prices of domestic goods converge to prices of similar imported goods.** We also account for how tax systems vary by region by assuming that residents in the West Bank face Palestinian customs duty rates while residents in East Jerusalem face Israeli customs duty rates, and that Gaza residents pay no customs duties.

## **4.4.2. VAT**

## **VAT simulation followed these steps:**

> 42 The property valuation data provided by the Government for the year 2017 had significant variation across cities for the valuation amounts. As a result, for the analysis, an average property value per governorate is applied.

> 43 Netting-down for customs duties means that self-reported household expenditure in the PECS needs to be divided by (1+customs duty rate)*(1+VAT rate). This allows the analysis to recover the households’ pre-fiscal expenditure before any taxes.

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- (i) Mapped VAT rates to PECS 2016/17 consumption items.

- (ii) Prepared the Augmented IO Matrix<sup>44</sup> for the West Bank and mapped the Augmented IO sectors to VAT rates and to consumption items (COICOP codes) in the PECS 2016/17.

- (iii) Calculated indirect effects based on the Augmented IO Matrix of the West Bank and the CostPush Model (Inchauste and Jellema 2018). The model applies the price shock of VAT rates to taxable IO sectors; output sectors that have used inputs that paid VAT will carry indirect effects.

- (iv) Excluded non-taxable categories such as self-production and gifts from the PECS 2016/17 consumption dataset. Netted down self-reported households’ expenditure.<sup>45</sup>

- (v) Calculated direct effects based on VAT statutory rates for the formal purchase share of all taxable items in the PECS 2016/17. The estimation of households’ formal purchase share (by decile) was imputed based on average consumption informal shares (by decile) estimated in similar countries available in Bachas et al. 2020.<sup>46</sup>

- (vi) Applied indirect effects<sup>47</sup> (calculated for the West Bank) for exempt formal items and for the informal purchase share<sup>48</sup> in the PECS 2016/17.

- (vii) Scaled-up the VAT simulation in the survey to match the VAT effective rate in the administrative accounts (total VAT relative to consumption).

**The VAT model accounts for the different tax systems applied by region:** We assume residents in the West Bank face Palestinian VAT rates, that residents in East Jerusalem face Israeli VAT rates, and that Gaza residents do not pay VAT.

**We apply the latest methodologies by accounting for informality in households’ purchases based on Bachas et al. (2020), and including VAT indirect effects (e.g., increases in prices of goods and services due to unclaimed VAT paid on production inputs)**<sup>**49**</sup> **following Inchauste et al. (forthcoming).** Accounting for consumption informality in the West Bank and Gaza is important because: (i) the size of the informal economy is large, estimated above 50 percent of GDP (IMF 2022)<sup>50</sup> ; and (ii) recent cross-country evidence shows that households’ consumption informality tends to be higher among poorer households, hence

> 44 The IO Matrix was augmented for sectors that have a mix of exempt and non-exempt products, based on a 50-50 share. These sectors were: agricultural products, water, accommodation services, transport, financial services, business services, education, and health.

> 45 The netting-down in the case of VAT consists in dividing self-reported gross expenditure of each product by (1+ VAT statutory rate) that corresponds to each product.

> 46 Consumption informality based on average from 10 comparator countries with similar WB income classifications available in Bachas et al. (2020): Bolivia; Cameroon; Comoros; Congo Rep.; Eswatini; Morocco; Papua New Guinea; Sao Tome; Senegal; Tunisia.

> 47 VAT indirect effects or cascading effects refer to the increase in final prices that comes from VAT paid over inputs. It is assumed that sellers that cannot reclaim input VAT credit (for example, those selling exempt or informal items) will pass-through their unrecovered VAT in the form of higher final prices to be paid by consumers. Source: CEQ Handbook, Chapter 7 (Jellema & Inchauste, 2018).

> 48 To estimate the informal purchase share by decile in the West Bank and Gaza, the estimations of “self-consumption” (nonmarket informal consumption available in the PECS 2016/17) was deducted from “total informal consumption” (average from 10 similar countries in Bachas et al. 2020).

> 49 In an ideal VAT system (without exemptions and informality), there would not be VAT indirect effects or cascading effects since all producers and sellers along the distribution chain are able to receive a VAT credit for the VAT they paid on their inputs. However, in the presence of exemptions and informality, the VAT input credit mechanism is broken. In the Cost-Push Model used in the current study it is assumed that sellers of exempt and informal goods cannot claim their VAT input credit, hence they passthrough their unrecovered input VAT through higher final prices paid by consumers.

> 50 IMF (2022). West Bank and Gaza: Selected Issues.

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increasing the progressivity of the VAT (Bachas et al., 2020). While the PECS 2016/17 does not have a place of purchase variable to proxy households’ consumption informality, this study imputed average consumption informality by decile based on estimates from similar countries available in Bachas et al. (2020). We calculated the indirect effects of the VAT for the West Bank region using the 2017 Input-Output table and the Cost-Push Model (Inchauste and Jellema 2018, Inchauste et al. forthcoming).<sup>51</sup>

## **4.4.3. Excises**

**We model the fuel excises for gasoline, diesel, and kerosene** . Consistent with previous indirect taxes’ assumptions. We only simulate fuel excises in the West Bank, whereas we assume individuals in Gaza pay zero excises. The model of excises does not account for households’ consumption informality given that fuel products are typically not prone to tax evasion.

## **The simulation of fuel excises followed these steps:**

- (i) Mapped excise rates to relevant fuel products in the PECS 2016/17. Given data limitations, the model uses 2017 fuel excise rates from the Israeli Tax Authority<sup>52</sup> ; this is a plausible assumption since the excise rates from the Palestinian Territories and Israel are similar to avoid arbitrage between both countries.

- (ii) Prepared the Augmented IO Matrix for the West Bank<sup>53</sup> and mapped IO sectors (fuel products) to relevant excise rates. Also, all IO sectors were mapped to the associated final goods (COICOP codes) from the PECS.

- (iii) Excluded non-taxable categories such as self-production and gifts from the PECS 2016/17 consumption dataset.

- (iv) Calculated indirect effects of fuel excises based on the Augmented IO Matrix for the West Bank and the Cost-Push Model (Inchauste and Jellema, 2018). The model applies the price shock of fuel excises (differentiated for gasoline, diesel, and kerosene) to the petroleum input sectors; output sectors that have used petroleum products as an input will carry indirect effects from fuel excises.

- (v) Calculated direct effects based on (estimated) quantities of gasoline, diesel and kerosene consumed by households in the West Bank and the fuel excise rates for each product. Quantities were estimated based on households’ self-reported expenditure in gasoline, diesel and kerosene divided by each products’ prices in 2017 (differentiate by region).<sup>54</sup> As explained above, Israeli fuel excise rates (2017) were applied for gasoline, diesel and kerosene quantities.

- (vi) Applied indirect effects of fuel excises in the PECS 2016/17 to all households’ products that have used petroleum as a production input.

# **4.5. Indirect subsidies**

## **4.5.1. Domestic electricity**

**Estimation of the electricity subsidies to the domestic consumers is based on the applicable tariff structure (Table 4-2) and estimated cost of supply.** There was no data available on the cost of electricity

> 51 See Inchauste and Jellema (2018), for an explanation of the methodology on indirect effects and the Cost-Push Model.

> 52 The 2017 (Israeli) excise rates used in the model were: gasoline (2.89 NIS/L), diesel (3.02 NIS/L) and kerosene (2.89 NIS/L). 53 The IO sector of “Petroleum products” was disaggregated between “gasoline”, “diesel” and “other oils” based on consumption shares calculated using the PECS 2016/17.

> 54 Fuel prices (2017) are differentiated for residents between East Jerusalem and West Bank.

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supply inclusive of the “distributional cost”. We estimated cost of supply of electricity to domestic consumers by taking the lower bound of the price range DISCOs paid while importing/purchasing the electricity (NIS 0.53) and adding a 20 percent margin to cover distributional costs, surcharges, and recoveries.<sup>55</sup> This results in an estimated average cost of supply of 0.636 NIS per kWh.<sup>56</sup> We then calculated the subsidy for each consumption slab by taking the difference between the cost of supply (0.636 NIS per kWh) and the tariff in that consumption slab. Table 4-2 describes the subsidies.

**Table 4-2 The estimated electricity subsidy per kWh ranges from 0.178 to -0.0371 in the West Bank**

**and Gaza**

Electricity subsidy <u>per kWh by consumption slab, West Bank and Gaza</u>

||**Quantity**<br>|**Subsidy**<br>|
|---|---|---|
|**Slab**|(kWh per<br>month)|(NIS per<br>kWh)|
|1|1-160|0.18|
|2|161-250|0.14|
|3|251-400|0.07|
|4|401-600|0.03|
|5|More than 600|-0.04|

Source: Authors’ estimates based on Prime Minister’s Office (2017)

# **We performed the following steps to simulate direct effects from the domestic electricity subsidy:**

- (i) Identified the amount of households’ expenditure on electricity based on the self-reported “electricity charges” in the PECS.

- (ii) Estimated the quantity of electricity consumed by dividing total expenditure on electricity by the tariff (which varies by consumption slab).

- (iii) Calculated the direct effect as the subsidy amount per kWh (between 0.178 and -0.0371) times the (estimated) electricity quantity (kWh) used domestically consumed per the PECS.<sup>57</sup>

- The analysis focuses on direct effects and assumes no indirect effects since the domestic electricity subsidy is only provided to households and not to electricity producers/distributors.

# **4.5.2. Fuel subsidies**

# **Simulation of gasoline and diesel fuel subsidies is based on self-reported PECS households’ expenditure**

**data and subsidy calculated from administrative data (0.0686 and 0.1962 NIS per liter for gasoline and diesel, respectively).**<sup>58</sup> The simulation calculates the direct effects of fuel subsidies for residents in the West Bank and Gaza, and indirect effects for residents in the West Bank only. The direct effects of subsidies on gasoline and diesel were calculated by multiplying the subsidy per liter of fuel by the

> 55 Estimation of distribution margin (inclusive of all surcharges and costs) of 20 percent in the electricity sector is provided by the World Bank Energy Team based on regional average distribution margins.

> 56 Cost of supply after 20 percent margin calculated as NIS 0.53/ KwH * 1.2.

> 57 Note that due to the data limitation, the subsidy estimation is based on assumption of “volumetric consumption” instead of Increasing block tariff (IBT). Furthermore, the estimation only includes “Tariff Differential subsidy” and not” cross subsidy” within the tariff structure.

> 58 The per liter subsidy for gasoline and diesel was calculated by taking the difference between the retail price and GDoP price for the year of analysis.

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estimated quantities of gasoline and diesel in the PECS 2016/2017. The quantity of household consumption of gasoline and diesel was estimated by dividing households’ self-reported expenditure in the survey by the 2017 final consumer price. The indirect effects of gasoline and diesel subsidies (used as inputs in the production process) were calculated based on the West Bank IO table and the “Cost-Push Model" (Inchauste and Jellema, 2018). We applied the indirect effects from gasoline and diesel subsidies to all applicable household residents’ expenditures in the West Bank<sup>59</sup> .

- **4.6 In-kind benefits**

**The assessment includes in-kind benefits for public education and public health.** Both allocation methods impute “average benefits” to users and individuals eligible for these public services, respectively, based on information from the PECS 2016/17 and government administrative data.

# **Education**

**This study follows the “average-cost approach” for users of public education services to allocate in-kind public education benefits.** First, the in-kind benefits for public education services (per student) were calculated at the national level based on administrative data of (executed) public expenditure on education divided by the number of total students enrolled in public schools from administrative accounts; different benefits were calculated for the basic and secondary levels of education. Second, the study infers potential beneficiaries from public in-kind education benefits in the PECS survey based on the following reported variables: (i) individuals currently enrolled in public schools; and (ii) self-reported information on “highest grade of education achieved” plus one year.<sup>60</sup> The admin numbers indicated that for 2017 there were 585,821 students enrolled in (public) basic education and 214,663 students enrolled in (public) secondary education. In the case of (public) basic education, the inference approach from the PECS resulted in a larger number of students than the administrative target<sup>61</sup> ; hence, a random simulation within the eligible pool was performed to sub-select the number of (public) basic students in the PECS that matched the administrative number.<sup>62</sup> Third for the students identified in the PECS as those enrolled in (public) basic and secondary education (calculated in the second step), the study imputes the average in-kind benefits differentiated for each education level (calculated in the first step).

# **Health**

**The analysis uses the “insurance approach” to allocate in-kind public health benefits.** First, the in-kind benefits from public health services (per individual) were calculated based on executed health expenditure data from administrative accounts (primary care versus hospitals) divided by the number of individuals insured under government insurance self-reported in the PECS. Second, the analysis tries to

> 59 All households’ expenditure items that have used gasoline or diesel as a production input will carry indirect effects from fuel subsidies.

> 60 The PECS does not have information on the current grade of education. We estimated this variable based on the highest grade of education achieved, plus one year for individuals currently enrolled in public schools. It is only possible to estimate the current grade for primary and secondary schooling.

> 61 Originally, the inference approach from the PECS resulted in 716,822 students enrolled in (public) basic education in the survey, 122 percent times higher than the admin target. After the random allocation, the number of (public) basic education students simulated in the PECS came down to 580,558 (99 percent of the admin target).

> 62 The random allocation approach was not needed for secondary education since the inference approach from the PECS resulted in 168,783 students enrolled in (public) secondary education according to the survey, which was 79 percent of the admin target. Hence, no random allocation was needed to sub-select students since there was no overestimation stemming from the PECS.

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infer potential beneficiaries of public health benefits in the PECS. Since the PECS does not have information on access to health services, the analysis focuses on the eligible population of public health services—that is, those individuals that self-report having “government health insurance” in the PECS. Third, we imputed the average health benefit (primary care versus hospital services) equally to all individuals benefitting from government health insurance.

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# **5 Headline results**

## **5.1 Poverty and inequality**

**This section assesses the joint distributional impacts of the main taxes and transfers modeled in the West Bank and Gaza.** Results include changes in national poverty (headcount and gap) and inequality (measured by the Gini coefficient).

**To assess the distributional impacts of taxes and transfers on poverty, we calculated the national poverty headcount and the national poverty gap at the different CEQ income concepts.** Since the CEQ income concepts starts from Disposable Income equated to Consumption, all CEQ income concepts are consumption-based (in real, per capita terms), hence consistent with the official poverty line. The results shown in Figure 5-1 show that the combination of taxes and transfers modeled increased the national poverty headcount by 8.4 percentage points from Market to Consumable Income (from 30.6 to 39.0 percent), while the national poverty gap increased by 1.0 percentage point from Market Income to Consumable Income (from 9.8 to 10.8 percent). Most of the increase in the national poverty headcount and poverty gap is the result of the change between Disposable Income and Consumable Income; this suggests that indirect taxes drive the poverty-increase.

**When pension is measured as a deferred income, the total poverty increase due to the portion of the fiscal system measured here** **_decreases_ to 7.6 percentage points** (Figure A.1). This suggests that the poverty-increasing impact of the pension contributions in the PGT scenario outweighs the povertyreducing impact of the pension income. This is likely because the numbers of individuals in deciles 1 and 2 that receive pension income are lower than the numbers that pay pension contributions, even though the total amount of pension income received in deciles 1 and 2 is higher than the total amount of contributions paid. See Annex A for a more detailed discussion of this result.

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<!-- Start of picture text --> Poverty by income concept (PGT scenario)<br>40 39.0<br>33.4<br>=a)DQ 30.6 29.3<br>£ 30<br>°<br>a<br>oa<br>D<br>8<br>=<br>o<br>2 320<br>o<br>2<br>><br>o4 11.63<br>& 98 10.8<br>10 79<br>0<br>Market Net market Disposable Consumable<br>G9 Headcount HS Gap<br>Slslotes: Authors’ estimates based on PECS 2016/2017; LFS 2017.<br>1] The official national poverty headcount matches poverty at Disposable Income.<br>2] We do not calculate poverty at Final income because we value the health and education transfers at the average cost of provision.<br><!-- End of picture text -->
~~-~~ 1(y Jalyy mn(y ,z)-—mn(y
**Almost 50 percent of the Consumable Income poor in the West Bank and Gaza experience some degree of FI due to the combination of taxes and transfers modeled, with an average amount of FI of NIS 41.7 per Consumable income poor person, per month, while 71 percent of the pre-fiscal poor population experience FGP, with an average amount of FGP of NIS 38.4 per Market income poor person, per month.** Figure 5-3a shows the proportion of the poor population that, relative to their pre-fiscal income levels, experience FI (depicted by a negative blue bar) and the proportion that experience FGP (depicted by a positive orange bar). Figure 5.3b shows the average monthly amount of FI (negative blue bar) and FGP (positive orange bar), per pre-fiscal and post-fiscal poor person respectively, in LCU.  Note that the shares of the poor population that experience FI and FGP at Consumable Income, in Figure 5.3, sum to a value greater than one because the FI is calculated as a share of the Consumable Income poor (i.e. 950,727 individuals divided by 1,929,374 Consumable Income poor individuals = 49.3 percent), whereas the FGP is calculated as a share of the Market Income poor (i.e. 1,067,067 individuals divided by 1,511,930 Market Income poor individuals = 70.6 percent).

**Of the net market income poor population, 30.1 percent experiences fiscal impoverishment due to the direct taxes on income and property and contributions to pensions, with an average amount of NIS 26.7 (USD 6.9) per month.** When including cash and near-cash direct transfers and pension income into the system, the proportion of the disposable income poor that experience FI is 20.9 percent, by an average amount of NIS 4.4 (USD 1.1) per month. The proportion of the market income poor that experience FGP due to the combination of direct taxes and transfers is 25.8 percent of the population, with an average gain of NIS 39.3 (10.2 USD) per month. Finally, when the indirect taxes and subsidies are included in the system (VAT, customs tax, and electricity and fuel subsidies), the share of the Consumable income poor population that experience FI is 49.3 percent, and the average value of FI increases to NIS 41.7 (10.8 USD) per month, while the proportion of the market income poor population that experiences FGP rises to 70.6 percent, with an average value of FGP of NIS 38.4 (USD 10.0) per month.

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<!-- Start of picture text --> Share of poor population Average amount per poor population, monthly<br>100 40 39.3 384<br>70.6 ><br>=<br>£i< 50 5= 6<br>3s<br>a258 3<br>3 0.0 3 0.0<br>BaSw 8a 0<br>ze 2 44<br>&r<br>8os<br>oOo Sot -20.9 5E<br>5 -50 neo<br>a -49.3 2<br>g<br>< 30.0<br>-100 -40<br>———— ett.7<br>Net market Disposable Consumable Net market Disposable Consumable<br>@ Fiscal Impoverishment MH Fiscal Gains to the Poor ‘Total Fl “Total FGP<br>erelotes: Authors' estimates based on PECS 2016/2017; LFS 2017.<br>i2 ] Fiscal impoverishment:gains to the poor:PercentPercent ofofMeerapopulationi)i) pop o orr at postat pre -fiscal income and i i) madeexperience poorergains by thein fiscalincome systdu e m.to the fiscal system.<br>[3] Pre-fiscal income is excluded from the graph because no fiscal impoverishment or fiscal gains can occur, by definition.<br>[4] Final income is excluded from the graph because we don’t measure changes in poverty at Final income.<br>[5] Sum of absolute value of bars doesn't add to 100 because percentages are calculated over poor populations at different income concepts.<br><!-- End of picture text -->
(comprised of the poorest 10 percent of households) received a net cash benefit equivalent to an increase of 53.4 percent of their Market Income; these households in the poorest decile benefitted more from direct transfers and indirect subsidies than total direct and indirect taxes that they had to pay. In contrast, the rest of the deciles were net cash payers into the fiscal system, with the cash loss after taxes and cashable transfers (reduction in Market Income) ranging from –1.4 percent in decile 2 to –19.7 percent in decile 10 (the richest 10 percent of households). The fact that decile 2 (which is below the official poverty line) experienced a cash loss is consistent with the national poverty increase estimated after the combination of taxes and cashable transfers modeled. While there was a slight poverty gap increase at the national level, the effect was very small and likely because of the net cash gain in decile 1. Also, the fact that the cash loss was higher for richer deciles relative to poorer deciles is consistent with the estimated inequality reduction after the combination of taxes and transfers modeled.

**Figure 5-4 Households in decile 1 are net cash beneficiaries of fiscal policy in the West Bank and Gaza**

Net cash position of households after taxes and transfers, by deciles <!-- Start of picture text --> Net cash beneficiary<br>100<br>Contributions<br>Direct taxes<br>50<br>Indirect taxes<br>Education<br>Health<br>Indirect subsidies<br>Direct transfers<br>0<br>Net total benefit<br>Net cash benefit<br>-50<br>Poorest 2 3 4 5 6 7 8 9 Richest<br>Decile of Market income<br>Percent of Market income<br><!-- End of picture text --> Source: Authors' estimates based on PECS 2016/2017; LFS 2017. Notes:

[1] Net cash benefit refers to the system including all direct and indirect taxes, transfers and subsidies, and excluding in-kind health and education transfers. [2] Net total benefit refers to the system including all elements, including in-kind health and education transfers.

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- **6 Marginal contributions and progressivity**

# **6.1 Marginal contributions**

**Marginal contributions are defined as the contribution a particular fiscal intervention makes to the measured outcome of interest (Lustig, 2022)** . Marginal contributions consider both the progressivity and the size of an instrument or group of instruments. They are calculated by measuring the change in a poverty or inequality indicator with and without the tax or transfer of interest. A positive marginal contribution in Figure 6-1 and Figure 6-2 below signifies that the tax or transfer is inequality- or povertyreducing while a negative marginal contribution means that the tax or transfer is inequality- or povertyincreasing. In this section we examine the marginal contributions to inequality and then poverty.

**Marginal contributions are measured here once all other** **_cash_ taxes and transfers are included in the system (at Consumable Income) given that this best represents the fiscal system for poverty estimates.** This can be more useful for explaining the final result of including or excluding a particular instrument, because the interaction of one instrument with the other instruments already included in the fiscal system can, at times, result in a starkly different marginal contribution estimate than if included at Market Income (i.e., with no other fiscal instruments included in the model). However, for a better understanding of the impact of a particular instrument it can be informative to examine the contributions of direct taxes and transfers at market income, indirect taxes and subsidies at disposable income, and in-kind benefits at consumable income (when measuring inequality). We therefore show the marginal contributions at Market, Disposable and Consumable income in Annex C. For example, the marginal contribution of the Pension income to poverty reduction at Market Income is 0.7 percentage points vs. 2.0 percentage points at Consumable Income (once the direct taxes and transfers, and indirect taxes and subsidies are included).

## **6.1.1 Inequality**

**Except for VAT (indirect effect), all instruments in the West Bank and Gaza are either inequalityreducing or have no effect.** Instruments do not affect outcomes in some cases because they are small (see, for instance, Figure 7-1 on the incidence of taxes and transfers).

## **The three instruments with the largest marginal contribution to inequality-reduction are all transfers:**

- In-kind benefits from public basic education have the largest marginal contribution to inequality reduction at 1.4 Gini points due to their large size and despite being less progressive than direct transfers (Figure 6-1). This is expected since poor households in the West Bank and Gaza have more people and more children attending public schools.

- The second largest marginal contribution to inequality reduction stems from in-kind benefits from public hospitals services at 1.3 Gini points. While they have the same level of progressivity as the public primary healthcare services, the expenditure size of the former is larger and so the marginal contribution is greater.

- These are followed by the CTP (direct transfer) at 1.2 Gini points. The large marginal contribution to inequality reduction from the CTP is expected given that it is targeted to the poor using a PMTF.

**The VAT, the largest of all taxes, has the next largest marginal contribution to inequality reduction at 0.8 Gini points.** This is due to a combination of two characteristics: its progressivity and its substantial size relative to a households’ consumption. Most of the marginal contribution from VAT stems from the direct effects (tax levied on final goods and services), while the indirect effects (price increase on informal and

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exempt items due to taxed production inputs) have a small (negative) effect on inequality reduction. While a VAT without exemptions, thresholds, or tax avoidance would have no impact on inequality (since the concentration of VAT would be similar to the concentration of consumption), in reality the tax is progressive given that the poor source a larger share of total consumption at informal places of purchase (Bachas et al 2020).

**Public secondary education benefits, public primary healthcare benefits, fuel excise (direct effect), nearcash social protection transfers, electricity subsidies (direct effects), pension income and pension contributions also make positive marginal contributions to inequality reduction (ranging between 0.6 and 0.1 Gini points) while the PIT has a neutral effect on inequality reduction.** Unusually, in the West Bank and Gaza, the PIT has a negligeable effect on inequality reduction (0.0 Gini points), while the VAT decreases inequality by 0.8 points. This can be attributed to the small size of the PIT and the comparatively flat structure of the tax system.

**VAT (indirect effects), Fuel excises and fuel subsidies have negative marginal contribution to the inequality reduction (Figure 6-4).** Finally, our estimates show that the indirect effect of VAT is the only fiscal component that increases inequality (with a marginal contribution of -0.1 Gini points) (Figure 6-4). As for fuel excises, only the direct effects decrease inequality (by 0.4 Gini points) as fuel is consumed more by wealthier households, while the indirect effect of the fuel excise has a negligeable effect on inequality reduction.<sup>69</sup>

> 69 Indirect effects of fuel excises represent about 75 percent of total fuel excises. The results show that for deciles 1-8, the largest source of indirect effects stems from “Taxi fares (public transport)” whereas for deciles 9-10, the largest source of indirect effects stems from “Electricity charges”.

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# **Figure 6-1 Almost all fiscal instruments in the West Bank and Gaza are either inequality-reducing or have no effect**

Marginal contribution to inequality reduction of each fiscal instrument, in Gini points, measured at Consumable Income <!-- Start of picture text --> Inequality reduction<br>VAT (indirect effect)-0.1<br>Fuel excise (indirect effect) -0.0<br>Customs (direct effect) -0.0<br>Fuel subs. (direct effect) -0.0<br>Fuel subs. (total) -0.0<br>Property -0.0<br>Fuel subs. (indirect effect) 0.0<br>PIT 0.0<br>Pension contributions 0.1<br>Pension income 0.1<br>Elec. subs. (direct effect) 0.1<br>Near-cash transfers 0.2<br>Fuel excise (total) 0.4<br>Fuel excise (direct effect) 0.4<br>Primary healthc. 0.4<br>Secondary educ. 0.6<br>VAT (direct + indirect effect) 0.8<br>VAT (direct effect) 0.9<br>Cash Transfer Program (CTP) 1.2<br>Hospital healthc. 1.3<br>Basic educ. 1.4<br>0 .5 1 1.5<br>Marginal contribution at Consumable income (Gini points)<br>Source: Authors' estimates based on PECS 2016/2017; LFS 2017.<br>Notes:<br>[1] Marginal contributions are calculated as the change in a poverty or inequality indicator that results with the inclusion of a tax or transfer of interest.<br>[2] A positive bar represents a reduction in poverty or inequality, while a negative bar represents an increase.<br><!-- End of picture text -->

# **6.1.2 Poverty**

**All transfers are either poverty-reducing or neutral.** The CTP (largest targeted social protection program) and pension income have the largest poverty reduction effects in the West Bank and Gaza, reducing the national poverty headcount by 2.2 and 2.0 percentage points, respectively. While wealthier households capture a larger share of pension income than their share of Market income, a portion of the transfer still goes to poorer households, and the transfer increases income in Decile 1 by 1.6 percent, and by 3.9 and 0.7 percent in deciles 2 and 3 respectively. Electricity subsidies (direct effects), fuel subsidies (direct and indirect effects), and near-cash transfers have a much smaller marginal contribution to poverty reduction at only 0.6 and 0.3 percentage points, respectively.

**All taxes either increase poverty or are neutral. Customs duties and VAT have the largest (negative) contribution to poverty reduction as they increase the national poverty headcount by 5.3 and 4.8 percentage points, respectively.** Although nationally the VAT places a larger tax burden on households relative to customs duties (at 7.3 and 6.3 percent of Market Income, respectively), the VAT increases

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poverty by less than the customs duties because it is a more progressive tax<sup>70</sup> (Figure 6-4). The total PIT contribution in the combined West Bank and Gaza only increases the national poverty headcount by 0.4 percentage points. This is because the PIT is a smaller and more targeted tax than indirect taxes, and because labor informality is high in the West Bank and Gaza and reducing with income (the share of formal workers ranges from 4.3 percent of workers in decile 1 to 11.8 percent in decile 10). Fuel excises are poverty-increasing, and their indirect effects are more poverty-increasing with respect to their direct effects (2.3 vs. 0.5 percentage points, respectively). The indirect effects of fuel excises have a larger marginal contribution to the poverty increase relative to the direct effects because they are larger in size (75 percent of total fuel excises simulated); and for households in deciles 1-8 the indirect effects from fuel excises stem from their use of public transport (taxi fares). **We do not show the marginal contributions of the in-kind benefits to poverty-reduction (Figure 6.2).** A typical CEQ Assessment does not measure effects from in-kind benefits on household purchasing power, as outlined in the section on methodology.

# **Figure 6-2 In the West Bank and Gaza, direct transfers and the direct effects of electricity subsidies are the only poverty-reducing instruments**

Marginal contribution to poverty reduction of each fiscal instrument, in percentage points, measured at Consumable income <!-- Start of picture text --> Poverty reduction<br>Customs (direct effect) -5.3<br>VAT (direct + indirect effect) -4.8<br>VAT (indirect effect) -3.0<br>Fuel excise (total) -2.7<br>VAT (direct effect) -2.5<br>Fuel excise (indirect effect) -2.3<br>Pension contributions -1.6<br>Fuel excise (direct effect) -0.5<br>PIT Poverty increasing -0.4<br>Property -0.0<br>Fuel subs. (direct effect) 0.0<br>Near-cash transfers 0.2<br>Fuel subs. (total) 0.3<br>Fuel subs. (indirect effect) 0.3<br>Elec. subs. (direct effect) 0.6<br>Pension income 2.0<br>Cash Transfer Program (CTP) 2.2<br>-6 -4 -2 0 2<br>Marginal contribution at Consumable income (percentage points)<br><!-- End of picture text --> Source: Authors' estimates based on PECS 2016/2017; LFS 2017.

Notes:

- [1] Marginal contributions are calculated as the change in a poverty or inequality indicator that results with the inclusion of a tax or transfer of interest. [2] A positive bar represents a reduction in poverty or inequality, while a negative bar represents an increase. [4] We don't calculate contributions to poverty for in-kind subsidies.

70 VAT Progressivity in this fiscal incidence study is driven by the fact that the model accounts for households’ consumption informality (which is higher among poorer households), which improves VAT progressivity (Bacha et al. 2020). In contrast, for the case of customs duties, the model assumes the Law of One Price.

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# **6.2 Progressivity**

**The** **_Kakwani_ Index is a summary statistic of progressivity.** For taxes, it is calculated by subtracting the concentration coefficient of the tax from the Gini coefficient of a reference income (in this case Market Income);<sup>71</sup> for transfers, the index is calculated by subtracting the Gini coefficient from the concentration coefficient of the transfer. A value greater than zero represents a progressive tax or transfer, while a value below zero represents a regressive tax or transfer. The minimum and maximum values of the Kakwani Index depend on the size of the Gini coefficient. With a Gini coefficient at Market income of 35.1, the maximum value of the Kakwani is 64.9 for taxes (100-35.1), and 135.1 for transfers (35.1+100). The values of the Kakwani Index for transfers (Figure 6-3) are therefore not comparable with those of taxes (Figure 6-4).

**Most fiscal instruments in the West Bank and Gaza are progressive at Market income except for fuel subsidies (direct and indirect effects) and pension income. The direct transfers and in-kind benefits from health and education are the most progressive instruments in the West Bank and Gaza.** The CTP and near-cash transfers score the highest on the Kakwani index (at 100.3 and 73.0, respectively). The inkind health and education benefits are substantially less progressive than the direct transfers – which is unsurprising given that the latter directly target the poor, particularly through the CTP program.<sup>72</sup> Hospital and primary healthcare both score 47.9 on the Kakwani Index, while basic and secondary education score 45.3 and 39.0 respectively.

**Fuel subsidies and pension income are regressive (they have a negative score on the Kakwani Index).** This is not unusual in either case since fuel subsidies generally benefit the wealthy who spend a larger share of their consumption on fuel, while Pension Income is mostly awarded to public sector employees.<sup>73</sup> This means that the rich are capturing a larger share of these transfers relative to their income shares than the poor; hence, these instruments represent an inefficient means of supporting the poor. While Pension Income is of course not designed solely to support the poor, it is nonetheless important to note that the inclusion of the pension system results in a large redistribution of income from pension contributors to pension recipients.

> 71 The concentration coefficient is a summary statistic of the concentration shares and is thus a measure of the absolute distribution of a tax or transfer. It is measured similarly to the Gini coefficient, and a positive concentration coefficient indicates that the rich pay a greater share of a tax (receive a greater share of a benefit) than their share of the population, while a negative concentration coefficient indicates the opposite.

> 72 Even though the CTP program could not be identified in the PECS, it is likely that the program contributes largely to the aggregate results found in “direct transfers”, since the CTP represents about 63 percent of Ministry of Social Development budget.

> 73 According to the PER (World Bank, 2016), as of September 2014, only 2.2 percent of contributors were from the private sector (3,350 out of 154,986 total contributors).

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# **Figure 6-3 All transfers are progressive, except for fuel subsidies and pension income**

Progressivity of transfers, measured by the Kakwani Index at Market Income <!-- Start of picture text --> a. Progressivity of transfers<br>Fuel subs. (direct effect) -23.0<br>Pension income -14.0<br>Fuel subs. (total) -8.3<br>Fuel subs. (indirect effect) -4.7<br>Elec. subs. (direct effect) 33.4<br>Secondary educ. 39.0<br>Basic educ. 45.2<br>Primary healthc. 47.9<br>Hospital healthc. 47.9<br>Near-cash transfers 73.0<br>Cash Transfer Program (CTP) 100.3<br>-50 0 50 100<br>Kakwani Index w.r.t. Market Income<br><!-- End of picture text --> Source: Authors' estimates based on PECS 2016/2017; LFS 2017. Notes: [1] The Kakwani Index is a summary statistic of progressivity [>0 = progressive]. [2] It is calculated for transfers by subtracting the concentration coefficient from the Gini coefficient.

**All taxes are progressive relative to Market income. The PIT is the most progressive, followed by the total VAT, the fuel excises, and the customs tax (with a score of 14.1, 12.6, 11.9 and 3.7 on the Kakwani Index respectively).** The PIT is only slightly more progressive than the total VAT (direct and indirect effects combined). This is because of the flat design of the PIT in the West Bank and Gaza with relatively few income brackets.<sup>74</sup>

**The progressivity of the VAT is primarily driven by its direct effects, with a Kakwani index of 19.5, higher than both the PIT and the indirect effects of the VAT (3.2 on the Kakwani index).** The direct effects are more targeted than the indirect effects due to exemptions and zero-ratings on certain strategic goods. However, the progressivity of the VAT is also partly due to our methodological approach which accounts for differential informal consumption across deciles. The poor have a higher share of informal consumption, thus making the VAT more progressive (Bachas et al. 2020).

**The direct effects of the fuel excise are the most progressive component of the fiscal system.** Although it is not designed for progressivity, the consumption patterns of wealthier households render it particularly progressive.

> 74 The PIT paid according to the West Bank and Gaza tax schedule has a Kakwani Index of only 13.1 compared to the PIT paid according to Israeli tax schedule which has a Kakwani Index of 57.6.

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# **Figure 6-4 All taxes are progressive. The PIT is the most progressive tax, however the direct effects of**

**fuel excises are the most progressive component of the fiscal system.**

Progressivity of taxes, measured by the Kakwani Index at Market Income <!-- Start of picture text --> b. Progressivity of taxes<br>VAT (indirect effect) 3.2<br>Customs (direct effect) 3.7<br>Fuel excise (indirect effect) 4.9<br>Property 5.9<br>Pension contributions 10.4<br>Fuel excise (total) 11.9<br>VAT (direct + indirect effect) 12.6<br>PIT 14.1<br>VAT (direct effect) 19.5<br>Fuel excise (direct effect) 26.0<br>0 5 10 15 20 25<br>Kakwani Index w.r.t. Market Income<br><!-- End of picture text --> Source: Authors' estimates based on PECS 2016/2017; LFS 2017. Notes:

[1] The Kakwani Index is a summary statistic of progressivity [>0 = progressive].

[2] It is calculated for taxes by subtracting the Gini coefficient from the concentration coefficient.

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# **7 Incidence and concentration shares by decile**

**This section shows the distribution of each tax and transfer both in absolute terms (concentration shares) and relative to Market Income (incidence).** Households are sorted by real, per capita market income and grouped into national deciles of equal population. Decile 1 represents the poorest households, while decile 10 represents the richest households. Measuring the incidence of taxes and transfers by decile shows the total size of a tax or transfer relative to the total size of income in that decile. Incidence therefore measures size and distribution relative to a reference income (in this case Market Income).

**Concentration shares, in contrast, measure the proportion of each tax or transfer paid or received by each decile.** The sum of bars in each decile, for each instrument, must sum to 1 or 100 percent, and so the height of the bars provides no indication of size, only of distribution. To determine whether the instrument is progressive, we need to analyze the distribution compared to the distribution of a chosen reference income, therefore we show Market Income (red dashed line in graphs). A negative bar signals a tax, and a positive bar signals a transfer.

## **7.1. Taxes**

**The incidence of the direct taxes (PIT, property taxes) is small across all the deciles, despite increasing more sharply than the indirect taxes (Figure 7-1a).**

While they are most concentrated among richer households (Figure 7-1b) they are (unusually) not much more progressive than the indirect taxes in the West Bank and Gaza, given the poor targeting of the PIT and the relatively small size of the property taxes (Figure 7-1).

**The incidence of the Indirect taxes is large relative to the direct taxes (Figure 7-1a).** The direct effects of customs duties (brown bar) have the largest incidence of all tax instruments across deciles 1-6 of Market Income; they range from 4.1 percent of Market Income in decile 1 (the poorest) to 5.9 percent in decile 10 (the richest). In contrast, in deciles 7-10, the incidence of the VAT is largest. The direct effects of the VAT (red bar) are larger than the indirect effects in the upper half of the population and increase more sharply with income. The direct effects range from 1.3 percent of Market Income in decile 1 to 6.5 percent in decile 10. The indirect effects of VAT (purple bar) range from 1.9 percent of Market Income in decile 1 to 2.8 percent in decile 10.  The incidence of fuel excise ranges from 2.0 percent of Market Income in decile 1 to 4.9 percent in decile 10. The direct effects (pink bar) are smaller (ranging from 0.3 in decile 1 to 2.3 in decile 10), while the indirect effects (grey bar) are larger (ranging from 1.7 in decile 1 to 2.6 in decile 10). The incidence of both the direct and indirect effects of the fuel excise is larger for richer deciles, reflecting that fuel is a luxury good and that even the consumption of goods into which fuel is an input, are more concentrated among richer households than income.

**The concentration of indirect taxes in deciles 1-3 is similar to the direct taxes, at 6.3 and 4.6 respectively of the total tax collected (Figure 7-1b) and increases only slightly less steeply than the direct taxes.** The share of the direct taxes concentrated in decile 10 is 28.8 percent of income - just higher than the share of the indirect taxes at 28.3 percent of income.

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**Pension contributions are fairly flat.** Their incidence ranges from 0.7 (decile 1) and 2.6 (decile 8) (Figure 7-1a). Their concentration is lower than the indirect and direct taxes in decile 10, with a concentration share of 24 percent, versus 28-29 percent for the indirect and direct taxes, respectively (Figure 7-1b).

**Figure 7-1 Of all taxes, the Customs Tax and VAT have the largest incidence across the distribution**

Taxes and contributions: Relative incidence and concentration shares <!-- Start of picture text --> a. Incidence: taxes & contributions<br>0<br>-5<br>-10<br>-15<br>-20<br>-25<br>Poorest 2 3 4 5 6 7 8 9 Richest<br>PIT Property tax Pension contributions<br>VAT (direct effect) VAT (indirect effect) Customs (direct effect)<br>Fuel excise (direct effect) Fuel excise (indirect effect)<br>Source: Authors' estimates based on PECS 2016/2017; LFS 2017.<br>Notes:<br>[1] Incidence is a measure of size and distribution relative to a reference income.<br>[2] Transfers are shown as a positive bar and taxes are shown as a negative bar.<br>[3] Households are ranked over Market income<br>Incidence (% of Market income)<br><!-- End of picture text --> 49
<!-- Start of picture text --> b. Concentration shares: taxes & contributions<br>30<br>20<br>10<br>0<br>Poorest 2 3 4 5 6 7 8 9 Richest<br>Decile of Market income<br>Direct taxes Contributions Indirect taxes Market income<br>Source: Authors' estimates based on PECS 2016/2017; LFS 2017.<br>Notes:<br>[1] Concentration shares show the proportion of each tax/transfer paid by / benefitting each decile. They sum to 100%.<br>[2] Households are ranked over Market income<br>Concentration shares (%)<br><!-- End of picture text -->

# **7.2. Transfers**

**The incidence of the social protection direct transfers is higher in poorer deciles; and the largest direct transfer is the CTP.** The incidence of the CTP is largest in the first decile and decreases steeply with income (Figure 7-2a) from 56.3 percent of Market Income in decile 1 to 0.04 in decile 10; this is consistent with the fact that the CTP is targeted to the poor through a PMT. The incidence of the social protection nearcash transfers is much smaller than the CTP in all but the top decile, ranging from 4.4 in decile 1 to 0.06 in decile 10.

**Poor households receive a larger share of direct transfers.** Almost 60 percent of the direct transfers are received by decile 1 and only 1.2 percent in decile 10.

**The incidence of the indirect subsidies is small.** The electricity subsidies are visible in deciles 1 to 5 only, they start at 1.8 percent of Market Income in decile 1, decrease to 0.6 percent in decile 5, and further to 0.2 percent in decile 10. The fuel subsidies are not visible at all – they start at 0.1 percent of Market income in decile 1 and increase to 0.2 percent in decile 10.<sup>75</sup>

**The share of indirect subsidies received by decile is increasing monotonically with income.** While decile 1 receives 6.8 percent of the total indirect subsidies, decile 10 receives 16.1 percent.

**In-kind benefits from public hospital healthcare constitute a substantial benefit for households.** They range from 16.8 percent of Market Income in decile 1 to 0.7 percent in decile 10, followed by in-kind

> 75 We do not separate out the direct and indirect effects in the graph as they would be too small to be visible.

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<!-- Start of picture text --> a. Incidence: transfers<br>100<br>_f-)<br>=<br>8<br>£ 80<br>0)<br>PE”4<br>o<br>=> 60<br>-fo}<br>&<br>a 40<br>°<br>®<br>3<br>2 20<br>0<br>Poorest 2 3 4 5 6 7 8 9 Richest<br>3 Pensions &% Cash Transfer Program (CTP) 19 Near-cash transfers<br>G8 Elec. subs. (direct eff.) | MEG) Fuel subs. (direct + indirect eff.) | HE Primary healthc.<br>[5 Hosp. healthe. 9 Basic educ. [3 Seco. educ.<br>Sonejotes: Authors' estimates based on PECS 2016/2017; LFS 2017.<br>[1] Incidence is a measure of size and distribution relative to a reference income.<br>(3{3] TransfersHouseholds areare shownranked as aover positiveMarket barincome and taxes are shown as a negative bar.<br><!-- End of picture text -->
<!-- Start of picture text --> b. Concentration shares: transfers<br>60<br>=<br>&— 40<br>oO<br>=<br>7)<br>(=<br>2<br>g<br>Is a<br>8 20 om<br>e) ae<br>1S) _-_-—-o ia<br>0<br>, fc a yg « : @g vo ion<br>Poorest 7 3 4 5 6 7 8 9 Richest<br>Decile of Market income<br>13 Direct transfers 4 Indirect subsidies MG Education ME Health -e- Market income<br><!-- End of picture text --> reliajotes: Authors' estimates based on PECS 2016/2017; LFS 2017. [1] Concentration shares show the proportion of each tax/transfer paid by / benefitting each decile. They sum to 100%. [2] Households are ranked over Market income
# **8 International comparison**

## **8.1 Inequality**

**This section compares fiscal policy effects on inequality across 63 countries assessed in CEQ standard indicators.** We measure this by calculating the reduction in the Gini coefficient from Market Income (prefiscal income) to Final Income (Market Income plus all taxes, transfers, and in-kind benefits from health and education). We refer to the Gini reduction as the “total redistributive impact”. If a country has been assessed multiple times, we include only the most recent datapoint.

**Globally, the total redistributive impact of the combination of taxes and transfers modelled ranges from 0.2 to 20.4 Gini points reduction).** The West Bank and Gaza achieves 6.5 Gini points of redistribution—a moderate result relative to other countries.

### **Figure 8-1 Total inequality reduction in the West Bank and Gaza is moderate relative to countries in other CEQ assessments**

Inequality reduction, Gini coefficient (change in Gini from Market to Final Income) <!-- Start of picture text --> 0<br>-5<br>West Bank and Gaza:<br>-10<br>6.5 Gini point reduction in inequality<br>-15<br>-20<br>-25<br>High incomeHigh income Upper middle incomeUpper middle income Lower middle incomeLower middle income Low inLow in c omeome<br>Source: World Bank estimations for the West Bank and Gaza based on PECS 2016-17. CEQ Data Center for the rest of the<br>countries.<br>Spain Uruguay Panama United States Croatia Mauritius Romania South Africa Argentina Brazil Mexico Namibia Georgia Venezuela Costa Rica Botswana Dominican Republic Colombia China Ecuador Thailand Peru Iraq Iran Turkey West Bank and Gaza West Bank and Gaza Belarus Malaysia Jordan Russia Albania Guatemala Paraguay Indonesia eSwatini Lesotho Zambia Tunisia Kenya Ukraine Honduras El Salvador Mongolia Bolivia India Nicaragua Moldova Egypt Tanzania Ghana Sri Lanka Comoros Cambodia Ivory Coast Uganda Burkina Faso Togo Mali Ethiopia Niger Gambia Tajikistan Guinea<br><!-- End of picture text --> Note: Pensions treated as government transfers in China, Georgia, Guinea, Mali, Mongolia, Niger, and West Bank and Gaza.

## **8.2 Poverty**

**We compare fiscal policy effects on poverty using the 2011 Purchasing Power Parity (PPP) international poverty lines.**<sup>76</sup> Estimates for the economies in each income group use the poverty line appropriate to that income level: US$5.50 per day for high income and upper middle income, US$3.20 per day for lower middle income, or US$1.90 per day for low income. We measure poverty impact by calculating the change

> 76 The International poverty lines have been updated to 2017 PPP but the results are not yet available in the CEQ database. The $5.50 in 2011 (PPP) line is the closest of the international poverty lines to the official national poverty line in the West Bank and Gaza.

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in the poverty headcount from Market Income (pre-fiscal income) to Consumable Income (Market Income after taxes and transfers, excluding in-kind benefits from health and education). We include 58 countries in total.

**Globally, total poverty change due to the combination of taxes and transfers modeled ranges from the worst case of an 8.9 percentage point increase in Armenia to the best case of an 8.4 percentage point decrease in Spain.** The fiscal system in the West Bank and Gaza increases the poverty rate at the $5.5 2011 PPP poverty line by 6.0 percentage points. Note, however, that this result can vary substantially depending on the poverty line used. At the $3.20 and $1.90 2011 PPP per day international poverty lines, the combination of taxes and transfers in the West Bank and Gaza is poverty- _reducing_ by 1.2 and 0.8 percentage points respectively.

Figure 8.2 Total poverty impact at the $5.50 line is severe relative to other CEQ assessments Percentage point change in poverty rate, 2011PPP international poverty lines (changes from Market to Consumable Income)

# **Figure 8-2 Total poverty impact at the $5.50 line is severe relative to countries in other CEQ assessments**

Percentage point change in poverty rate, 2011 PPP international poverty line (changes from Market to Consumable Income) <!-- Start of picture text --> 10<br>8<br>West Bank and Gaza: 6.0 percentage point increase in poverty rate<br>6<br>4<br>2<br>0<br>-2<br>-4<br>-6<br>-8<br>-10<br>High incomeHigh income Upper middle incomeUpper middle income Lower mLower m idd le incomele income Low Low incom ee<br>Spain Mauritius United States Panama Chile Uruguay Romania Argentina Venezuela Iraq Ecuador Jordan Thailand Paraguay Russia Iran Malaysia Colombia Russia Indonesia South Africa Costa Rica Dominican Republic China Botswana Mexico Peru Namibia Guatemala Brazil Turkey West Bank and Gaza West Bank and Gaza Albania Armenia Ukraine Bolivia Sri Lanka Vietnam Nicaragua Moldova Comoros India Tunisia El Salvador Honduras Zambia eSwatini Lesotho Ghana Ivory Coast Kenya Tajikistan Ethiopia Uganda Guinea Burkina Faso Togo Tanzania<br><!-- End of picture text --> Source: World Bank estimations for the West Bank and Gaza based on PECS 2016-17. CEQ Data Center for the rest of the countries.

Note: Pensions treated as government transfers in China, Georgia, Guinea, Mali, Mongolia, Niger, and West Bank and Gaza.

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- **9 Macro-validation and limitations of the analysis**

- **9.1 Macro-validation**

**This section presents an overview of how well each instrument is modeled by comparing survey estimations with official fiscal administrative data.** We call this process “macro-validation” because it allows us to validate our methodology by comparing the results in the survey at the national level with the results in the national accounts (Table 9-1). Note that East Jerusalem is excluded for all the instruments shown in the table as well as for consumption.

- **Total consumption:** As outlined earlier, Disposable Income in this study is equivalent to the household consumption aggregate in the PECS 2016/17. The survey has good coverage of households’ consumption as total consumption in the PECS represented about 81 percent of the official aggregate in national accounts.<sup>77</sup> We expected a slight gap between the survey and macro estimations of household consumption due to methodological differences between the survey and national accounts and both non-response rates of wealthier households and underestimation of income levels of wealthier households (see the section on limitations).

- **Taxes:** All direct taxes simulated in the PECS have good coverage of their respective administrative absolute values; that is, the amounts allocated in the survey are close in size to the amounts reported in the executed budget. The PIT covers 85 percent of the official administrative value of tax collections; pension contributions covered 108 percent and the property tax covered 84 percent. Indirect taxes—customs duties, VAT and fuel excise—covered 66, 95 and 73 percent, respectively, of total administrative value of tax collections. The Property Tax, and the VAT were scaled to match the effective rate relative to consumption (0.03 and 6.6 percent, respectively).

- **Transfers:** The total of CTP and in-kind transfers in the survey covered 65 percent of the administrative data, where income from pensions covered 107 percent (similar to the pension contributions). The value of indirect subsidies from domestic electricity and fuel (jointly) compared to the official administrative value cannot be estimated because the survey data includes both implicit and explicit subsidies, unlike the administrative data.  The value of in-kind benefits from primary and hospital public services both represented 85 percent of the administrative value. Lastly, for in-kind benefits from public education, the survey estimates covered 99 percent of the administrative value for basic education and 79 percent for secondary education. Originally basic education benefits were overestimated suggesting that the PECS 2016/17 overestimates total students enrolled in basic education at public schools. Recipients of the basic education subsidy are therefore scaled down as discussed in the methodology section. 78

> 77 It is not clear whether the national accounts amount includes East Jerusalem or not. If it does, then it is more appropriate to compare it with consumption including East Jerusalem also, which would result in a ratio of 95 percent.

> 78 As highlighted in the methodology, one limitation of the PECS is that the education model did not allow to identify ‘current grade where the student is enrolled’. Hence the current grade was estimated as ‘highest grade achieved’ + 1 year if the student was currently attending a public school.

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# **Table 9-1 The ratio of the amount allocated in the survey to the amount recorded in the budget ranges from 65% (government transfers) to 108% (for pension contributions)**

Macro-validation of the fiscal incidence analysis in the West Bank and Gaza, 2017

|**M**<br>**Scenario : Pensio**|**ACROVALIDATI**<br>**ns as Governme**<br>|**ON**<br>**nt Transfers(**<br>|**PGT)**|**Ratio**|**w.r.t.**|
|---|---|---|---|---|---|
||**Value in NI**|**S Millions**|**Ratio**|||
|||||**consu**|**mption**|
|**Fiscal instrument**|||**PECS:**|||
||**PECS**<br>**2016/17**|**Admin**<br>**2017**|**Admin**|**PECS**<br>**2016/17**|**Admin**<br>**2017**|
|**Consumption**|44 742.3|55 087.2|81.2|100.0|100.0|
|**Direct Taxes and contributions**|1 146.7|1 123.9|102.0|2.6|2.0|
|Personal Income Tax (PSE)|220.3|260.0|84.7|0.5|0.5|
|PropertyTax|12.0|14.3|84.2|0.0|0.0|
|Pension contributions|914.4|879.2|104.0|2.0|1.6|
|**Direct Transfers and contributory pensions**|2 285.7|2 803.7|81.5|5.1|5.1|
|Income from contributory pensions|1 173.1|1 093.2|107.3|2.6|2.0|
|Govt assistance (cash and in-kind)|1 112.6|1 710.5|65.0|2.5|3.1|
|Cash Transfer Program(CTP)|982.9|||||
|In-kind transfers|129.7|||||
|**Indirect Taxes**|8 505.7|10 979.5|77.5|19.0|19.9|
|VAT|3 468.2|3 646.1|95.1|7.8|6.6|
|Direct effects|1 959.9|||||
|Indirect effects|1 669.6|||||
|Customs Duties|2 926.3|4 429.9|66.1|6.5|8.0|
|Fuel excise|2 111.3|2 903.5|72.7|4.7|5.3|
|Direct effects|598.4|||||
|Indirect effects|1 512.8|||||
|**Indirect Subsidies**|333.3|*, **|n.a.|0.7|n.a.|
|Fuel|110.4|*|n.a.|0.2|n.a.|
|Direct effects|21.3|||||
|Indirect effects|89.1|||||
|Electricity (direct effects)|223.0|**|n.a.|0.5|n.a.|
|**In-Kind Benefits**|3 941.9|4 496.3|87.7|8.8|8.2|
|**Health**|**1 723.7**|**2 032.2**|**84.8**|**3.9**|**3.7**|
|Primary|424.1|500.0|84.8|0.9|0.9|
|Hospital|1 299.6|1 532.2|84.8|2.9|2.8|
|**Education**|**2 218.2**|**2 464.1**|**90.0**|**5.0**|**4.5**|
|Basic|1 362.2|1 377.8|98.9|3.0|2.5|

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Secondary 856.0 1 086.3 78.8 1.9 2.0 Note: Own elaboration. Survey estimates correspond to authors’ simulation of the fiscal incidence model; for indirect taxes, survey estimates correspond to tax collected from West Bank since the PA only collects taxes in this region. For transfers, survey estimates include both West Bank and Gaza since the PA distributes public expenditure in both regions. Fuel excise numbers are sourced from Ministry of Finance monthly reports, Personal Income Tax numbers are sourced from the Income Tax Department of the Ministry of Finance, while pension contribution estimates are from 2014 and imputed based on information on number of each scheme’s number of active contributors, average wage, and rate, sourced from the World Bank (2016).

* Bifurcated amount of government spending/allocation for fuel subsidy is not available. IMF estimates (2017) for the fuel subsidies indicates an amount of NIS 251 million which includes both implicit and explicit subsidies and is therefore larger than the estimate of total indirect subsidies discussed elsewhere in the report.

*** Bifurcated amount of government spending/allocation for domestic electricity subsidy is not available. The closest estimate of the size of the implicit and explicit subsidy is from 2015. This includes direct and indirect effects, however, and so our estimate is expected to be substantially smaller given that it only includes domestic subsidies.

# **9.2 Limitations**

## **9.2.1 Direct taxes and pension contributions**

## **Personal Income Tax (PIT)**

**The main challenge in modeling the PIT was the complexity involved.** Two different tax systems were modeled depending on region and worker status, and each with numerous tax exemptions and deductions. In both systems, information on the order and size of the deductions and exemptions was lacking.

**The PECS 2016/17 also does not specify whether income data is net or gross.** It was assumed that employees would provide their income net of tax, while employers or self-employed workers would be more likely to report their gross income.

A description of the detailed challenges faced for each deduction can be found in Annex B.

## **Pension contributions**

**The latest administrative numbers available on pension income and contributions are a few years out of date, from December 2013 and September 2014.** There were also a number of different schemes which made it complex to understand and implement.

## **Property tax**

**The main limitation for the estimation of the property tax is that there were several pieces of information that were not available in the PECS 2016/17 dataset, including:**

- (i) The area of the building and number of floors. This would be used to estimate the annual rental value of the building.

- (ii) The lease contract information. Having this information would be useful because the value of the tax varies with occupancy status (rented; prepared for rent; inhabited by the owner). To overcome this limitation, the modeling has proceeded with the assumption that all the properties are inhabited by the owners themselves.

- (iii) For Land evaluation, in lieu of the missing survey data, administrative data (by city) on evaluation was used and it was assumed that the valuation value is “average value per property” and not “per square meter”. Due to the lack of update in the evaluation, the evaluation amounts for some

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municipalities seems very high and varies a lot for several reasons (commercial area, industrial etc.).

- (iv) Land area information was not available to estimate the annual rental value of the property.

- (v) Informality in the payment of property tax. To overcome this limitation, the model applied proportional downscaling to match the effective property tax rate in the administrative data (relative to consumption).

# **9.2.2 Indirect taxes**

# **The main limitations for the VAT model are:**

- (i) We assume households purchase goods and services in the same region where they live.

- (ii) There is no place of purchase variable nor a secondary study on consumption informality for the West Bank and Gaza.

- (iii) We only applied indirect effects from VAT to West Bank residents.

To address the second limitation, we used estimations of consumption informality by decile based on an average from 10 similar countries (available in Bachas et al. 2020).

**In the case of customs duties, the major challenge is that we do not have an “imported” dummy in the PECS (a limitation of most household budget surveys).** To address this limitation, we assume the “Law of One Price”—that is, that prices of domestic goods converge to prices of similar imported goods. In applying the Law of One Price for simulating customs duties, we could overestimate the incidence of this tax, particularly if there are price differences between similar domestic and imported products and if poor or rich households have different consumption patterns between domestic and imported products. However, sensitivity analysis conducted for other fiscal incidence studies shows that alternative methods are likely to yield similar results.<sup>79</sup>

**Lastly, we assumed that Gaza residents are not paying indirect taxes.** We could be underestimating the tax burden for Gaza residents if they do pay informal taxes to the _de facto_ authorities, or if indirect effects of taxation from using taxed production inputs from the West Bank affect Gaza residents.

# **9.2.3 Indirect subsidies**

**The main limitation to the estimation of the electricity subsidy is lack of administrative data on “average cost of supply” of electricity by DISCOs to the domestic consumers.** Data is also not available on distribution margin of the DISCOs. Additionally, the PECS only provides the information about the “electricity charges” paid by the households. It does not provide the information about the “type of meter” households have. The application of “incremental block Tariff” is based on the type of meter. In the absence of this information, it is assumed that electricity tariff is volumetric.

> 79 In a fiscal incidence analysis of Benin in 2018 the authors model customs using two different assumptions: in the baseline they assume that domestic and imported goods are differentiated enough (in terms of quality and type of good within IO sector) to prevent price convergence, while as a sensitivity analysis they assume that domestic and imported goods belong to the same IO subsector and are of similar levels of quality, such that the Law of One Price (LOOP) applies. (Goldman et al., 2022). They find little difference in the results of the two methods, with a slight increase in the Kakwani Index from 5.7 to 5.8 with the LOOP assumption, no change in the marginal contribution to inequality of 0.2, and a slightly greater marginal poverty increase decrease in the marginal contribution to poverty reduction from –1.9 to –2.0 (i.e., a larger poverty increase).

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# **9.3 Direct transfers**

**The PECS only provides aggregate data of households’ income from social protection (e.g., government assistance).** This includes one variable for “total cash” and another variable for “total in kind”, the latter labeled as near-cash transfers in our model. Hence, it was not possible to disaggregate transfers households received for each of the four main specific social protection (cash transfer) programs in the country. Currently, the model infers that the cash-transfers reported in the PECS are from the CTP program based on cross-validation with other administrative data. However, if the team had access to the PMT formula of the CTP and threshold or the allocation methods for other programs, it would have been possible to do a more detailed simulation of social protection programs in the West Bank and Gaza.

## **9.3.1 Education**

**Data limitations in the PECS 2016/17 required that we made assumptions about beneficiaries of public education benefits.** The PECS 2016/17 survey does not have information on “current grade of education”; instead, this study inferred beneficiaries combining self-reported information on “highest grade of education achieved (plus one year)” and “currently enrolled in public education”. The analysis also imputes an average education benefit calculated at the national level; implicitly, this assumes that students in the West Bank and Gaza receive the same benefits across regions at each education level. Information on public expenditure by education level, disaggregated by region, would improve the calculation of education benefits. Lastly, due to PECS data limitations, it was not possible to analyze distributional effects of public expenditure from other levels of education (pre-primary and tertiary).

## **9.3.2 Health**

**The PECS does not have information on access to public health services.** By using the health-insurance approach (focusing on individuals reporting coverage of government health insurance in the PECS), the model implicitly assumes that eligible individuals do not have significant barriers to access public health services. However, in practice, usage of health services by the eligible population could be lower, particularly in Gaza where most residents use UNRWA-provided health services. Hence, using the healthinsurance approach could overestimate the in-kind health benefits among Gaza residents. We also calculated public health benefits at the national level, assuming that benefits for each health level are the same for residents in the West Bank and Gaza. However, having public health expenditure data disaggregated by health service and region would improve calculation of health benefits.

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# **10 Conclusion and next steps**

## **10.1 Conclusion**

**The fiscal incidence analysis for the West Bank and Gaza in 2017 shows that the combination of taxes and transfers modeled reduced inequality but increased poverty.** Inequality decreased by 6.5 Gini points, from 35.0 at Market Income to 28.5 at Final Income), while the national poverty headcount increased by 8.4 percentage points, from 30.6 percent at Market Income to 39.0 percent at Consumable Income. This pattern is common in developing countries where the tax collection is mostly comprised of indirect taxes and social protection coverage is limited.

**The large increase in poverty due to combined taxes and transfers suggests that fiscal redistribution in the West Bank and Gaza could be improved.** Only the poorest decile is a net-receiver of the combination of taxes and transfers modeled in this study, all other deciles were net payers. Almost 50 percent of the poor population at Consumable Income (roughly 19 percent of the total population) experienced some degree of fiscal impoverishment—that is, a reduction of their Market Income after they paid taxes and received transfers.

**Most fiscal interventions were progressive relative to Market Income.** We measured this using the Kakwani Index. The regressive interventions, looking at Market Income, were fuel subsidies, pension income, and property tax.

**The marginal benefit of including in-kind benefits from health and education into the system accounts for 40 percent of the reduction in inequality, while the marginal benefit of including the CTP into the system accounts for 18 percent of the inequality reduction.**<sup>80</sup> We measured the marginal contributions of each instrument to either reducing inequality or reducing poverty **.** The large marginal contributions to inequality reduction stemming from public basic education is expected since poor households have more children that access basic public schools. The model could, however, overestimate the inequality reduction stemming from in-kind public health benefits considering that benefits were imputed based on access to public-health insurance rather than actual usage of public health services (not available in the PECS 2016/17). Yet human capital outcomes as measured by the SES-Disaggregated Human Capital Index are relatively even across socioeconomic quintiles compared to data for other countries,<sup>81</sup> suggesting that public spending on education and healthcare has been effective at reducing gaps in quality.

**The VAT and customs duties are important tools for domestic revenue mobilization, but they represent the main drivers of poverty increase in the West Bank and Gaza.** While VAT and customs duties were progressive overall, the large burden they cause explains why they represent the largest marginal contributions to the national increase in poverty. Pension contributions and the PIT also increase poverty, although to a lesser extent due to their smaller size.

**Strengthening the social protection transfer system could improve poverty and inequality reduction.** Cash transfers from social protection (CTP) and pension income contribute most to poverty reduction in

> 80 The marginal contribution of the in-kind benefits at Consumable income is 2.9 Gini points, while the CTP has a marginal contribution at Consumable income of 1.2 Gini points. 81 Avitabile et al (2020).

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the West Bank and Gaza, while contributing to inequality reduction. However, their coverage is still limited in deciles 2 and 3. Improving social protection coverage among deciles 2 and 3 to compensate for taxes they pay could reduce inequality and poverty in the West Bank and Gaza. Using targeted programs such as the flagship CTP (targeted through the PMT) could represent the most effective way to redistribute resources in the country.

# **10.2 Next steps**

**Future extensions of the current study should aim to reassess the incidence of public health benefits based on actual access to health services.** This could be done using secondary household surveys such as the Demographic and Health Survey or the next PECS, for which data are being collected in 2023.

**Future study should also aim to include the simulation of the flagship and targeted CTP.** In the PECS 2016/2017, social protection transfers are aggregated as government cash assistance versus government near-cash assistance, making it impossible to disaggregate the impacts of individual social programs. The current analysis infers that the CTP is the reported cash assistance program in the PECS. The PECS 2023 will have more disaggregated data of social protection programs to refine this analysis. On the other hand, having access to the PMT targeting formula of the CTP would allow to perform other policy-reform simulations, such as expansions of coverage of the CTP beyond that reported in the PECS. This could be useful to analyze the impact of social protection compensation measures.

**Finally, the fiscal incidence model we developed for the West Bank and Gaza could be used to inform likely distributional effects for new PA policies and reforms.** Examples of these reforms include adjusting the electricity tariff structure to increase progressivity and decrease costs to the poor, reducing the fuel subsidy to increase fiscal space, updating PIT tax brackets, and expanding the number of municipalities applying property tax. Furthermore, the PECS 2023 survey has been updated to address some of the limitations highlighted in this analysis. For example, the PECS 2023 is better able to disaggregate social protection programs’ coverage and payments to, and use of, different healthcare facilities.

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