As Israel carries out the latest stage of its devastating military assault on Gaza in the southern city of Rafah, pressure has mounted on its relationship with the United States. Yet it is in the West Bank where the Biden administration’s stalwart support for Israel’s right-wing government may face its most difficult test. A recent decision by far-right Israeli Finance Minister Bezalel Smotrich to withhold the equivalent of $46 million in tax revenue from the Palestinian Authority (PA) has brought on criticism from both U.S. Treasury Secretary Janet Yellen and National Security Advisor Jake Sullivan for further threatening the dire economic situation in the West Bank.
PA finances, long precarious, are currently in freefall, with the government noting that it could only pay half of civil service salaries in May. According to the Paris Protocols, an agreement signed in 1994 between Israel and the Palestine Liberation Organization, Palestinian customs revenues are collected by Israel and forwarded to the PA. Israel also collects income taxes on Palestinians working in Israel, the bulk of which are passed on as well. They are the single largest input into the PA’s budget, constituting around $188 million per month, or roughly 65 percent of recurrent revenues. They are Palestinian monies and are not Israel’s to withhold.
The Biden administration has made clear its intent to strengthen the PA in preparation for its day-after plan in Gaza, which it hopes to steer toward an eventual two-state solution.. For this to happen, PA finances will need to be stabilized and made more routine and predictable. To achieve this goal, Israel will need to stop using PA taxes and customs revenues as a pressure point for achieving various ad-hoc policy objectives. The timely and routine transfer of these resources must be assured to maintain the stable flow of funds to Palestinian schools, hospitals, and social services.
The ongoing challenge is that Israel has for decades interfered with these transfers, turning the tap on and off and, in the process, wreaking havoc on Palestinian finances. Between 1997 and today, Israel has intervened to halt or reduce these transfers no fewer than 13 times. Israel earns interest on these funds and, in the case of taxes, receives a large fee for collecting and distributing them to the PA.
In the wake of the Hamas-led attacks of October 7, Israel cut the flow of funds to pay for civil service salaries and electricity in Gaza. As the economic situation across the occupied territories has deteriorated, the finance minister’s constant meddling has pushed the crisis from bad to worse. In January 2023, Smotrich withheld $39 million in transfers following the PA’s decision to ask the International Court of Justice to rule on the legality of Israel’s occupation. In February, he arbitrarily withheld another $39 million in PA revenues.
No government can function effectively when such a significant proportion of its revenues are subject to ad-hoc cuts and delays. For some in the cabinet of Israeli Prime Minister Benjamin Netanyahu, that is the point—Smotrich has a history of targeting the PA and seeking its collapse, even as Israel’s security establishment warned that this would threaten Israel’s security. Given the international community’s support for a two-state solution and a revitalized PA, such efforts are profoundly counterproductive. In late December, President Biden and Benjamin Netanyahu reportedly had a “frustrating” call, in which the president told Netanyahu that he needed to overcome right-wing resistance and transfer customs revenues to the PA. Eventually, a temporary compromise was worked out, in which these revenues would be given to Norway to hold them in trust and transfer them only with Israeli approval.
A fiscal grand bargain of sorts is needed. The United States and other donors need to ensure the timely delivery of these monthly payments to the PA and hold Israel financially responsible for any delays or unilateral appropriation of these payments. The best way to do this would be to withhold American grants to Israel under the Foreign Military Financing (FMF) program by an amount comparable to any withheld revenues. (The United States stopped providing Israel with economic aid in 2007.) Given the size of funding, any reduction in FMF grants commensurate with withheld transfers would be modest and would not compromise Israel’s security. Yet it would send an important signal. And there is precedent for such an action. Despite fierce domestic opposition, during the George H.W. Bush Administration, Secretary of State James Baker III successfully withheld around $10 billion in U.S. loan guarantees to help resettle thousands of Russian immigrants until Israel curbed its illegal settlement expansion in occupied territory.
The PA also has significant work to do. Much greater transparency and accountability will be required from Palestinian finances, particularly involving resource flows to Gaza and the payment of salaries and electricity charges. There is scope to significantly expand the PA’s domestic revenue base and crack down on tax avoidance—steps that the PA could take on its own with assistance from the donor community. More broadly, mainstreaming accountability and transparency in administration, and doing so in a way that fosters inclusion so that citizens see that the administration is functioning and delivering results equitably, will play an important role in an eventual Palestinian state. Without reform, resources that could be used for rebuilding and development will be squandered, public perceptions of corruption will continue, and social discontent will fester deepening fragility.
The stabilization of PA finances around a more predictable set of revenue flows will make an essential contribution to a Palestinian state, whatever its eventual political composition may be, as will the adoption of more transparent and accountable reporting structures and improvements in domestic revenue mobilization. Linking the elements together will foster a set of incentives that should generate a virtuous cycle for the future.
