The End of the Era of the Israeli-Palestinian Customs Envelope

The relevancy of the Israeli-Palestinian Customs Envelope is eroding after Israel's disengagement from Gaza.

Essence of Warning1

The Customs Envelope arrangement, stipulated in the Oslo Agreements, sets a unified regime of customs and indirect taxes (with limited exceptions) in Israel, Gaza and the West Bank. According to the arrangement, Israel maintains control of the customs points on the external perimeter, collects revenues and reimburses the Palestinians for their share through the Revenue Clearance Mechanism. Additionally, it includes a mechanism for calculation of indirect taxes.

The relevancy of the Customs Envelope is eroding due to (1) the construction of the Security Fence; (2) the sequence of the Roadmap and the deferment of Permanent Status Agreement; (3) restrictions on movement of people and goods; and (4) Israel's withdrawal from the external perimeter of the Gaza Strip.

Therefore, the GOI must consider ways to adjust the Customs Envelope arrangement to the new reality, or even to dismantle or replace it with an alternative economic arrangement.

Existing Mindset – Israel and the Palestinians are a Unified Customs Unit

Since the Six Day War Israel viewed its territory, together with that of the West Bank and Gaza, as a single customs unit. Hence, Israel enforced a unified customs and taxation regime on all transfer of goods between these territories and third countries.

The Oslo Process did not change this principle and the Paris Protocol (4/94)2 validated this regime and established the Customs Envelope. This arrangement sets a unified customs regime on transfer of goods (with limited exceptions) and similar (but not identical) indirect taxes. Additionally it sets a Revenue Clearance Mechanism, which reimburses the Palestinians for their share of collected revenues.

The logic behind this arrangement was based on the following working assumptions and principles:3

  1. Up until the Permanent Status Agreement, there will not be a physical boundary between Israel, Gaza and the West Bank.
  2. Free movement of goods, labor and capital must be ensured, subject to security considerations;
  3. The economic arrangement with the Palestinians was of provisional nature and would be revisited with the signing of a Permanent Status Agreement (which was supposed to be concluded in May 1999);
  4. Attributes of Palestinian statehood, including attributes of economic sovereignty, such as the right to sign agreements with third parties or issue a currency, are to be restricted;4
  5. Gaza and the West Bank are a Single Territorial Unit, and are therefore subject to the same economic regime.5

Today, the Paris Protocol continues to constitute the formal basis for economic relations between Israel and the PLO, although many of its provisions are not implemented.

The Disengagement Plan presented a paradox. On one hand, its political goal was to end Israel's responsibility over Gaza (hereinafter: End of Responsibility). On the other hand, it maintained the validity of the existing economic arrangements between Israel and the Palestinians.

According to the cabinet resolution (8/8/05), the continuation of the Customs Envelope arrangement would be conditional upon Palestinian consent to transfer the Rafah crossing (which serves for transfer of goods) to Kerem Shalom. Should the Palestinians refuse, the GOI will act to establish a customs regime on the Israel-Gaza border and exclude Gaza from the Customs Envelope.

Diverging Reality

Trends that are undermining the existing mindset are rendering the Customs Envelope irrelevant:

All the assumptions that led to the establishment of the Customs Envelope within the framework of the Oslo Accords have been eroded:

  1. Israel and the West Bank are being separated by the security fence, and Gaza is already surrounded by a fence;
  2. Passage of goods, capital and labor between Israel, the West Bank and Gaza has diminished dramatically due to Palestinian violence on one hand, and restrictions imposed by Israel on the other hand;
  3. A Permanent Status Agreement including a comprehensive economic arrangement is not probable in the near future. The Customs Envelope arrangement, which was supposed to be temporary, continues to function as the foundation for economic relations between Israel and the PA;
  4. The PA has gained numerous attributes of statehood. Moreover, it seems that the establishment of Palestinian statehood is now an Israeli interest.6 Considering Israel's wish to end its responsibility, and prior to the implementation of the Second Phase of the Roadmap, which includes the establishment of a Palestinian State with Provisional Borders (PSPB), it may be advisable to rescind some of the restrictions on Palestinian sovereignty and provide the PA with a higher extent of economic independence.

The Disengagement Plan would probably be followed by further fundamental transformations in the Israeli-Palestinian system that will continue to erode the logic behind the Customs Envelope:

  • On one hand, Israel is subjected to international pressure to maintain a unified customs regime in Gaza and the West Bank;
  • On the other hand, (1) Israel wishes to end its responsibility over Gaza, but not over the West Bank; (2) ending Israel's presence in Gaza's airspace, territorial waters, and the Gaza-Egypt border crossing will obstruct the enforcement of the Customs Envelope.

Implications

Macro-Economics:

  1. On the Palestinian Side – A high percentage of Palestinian trade is conducted vis-à-vis Israel. Transferring the Israeli custom points to the Palestinian-Israeli border will obstruct Palestinian trade and severely damage Palestinian economy.
  2. On the Israeli Side – Trade with the Palestinians is not a main component of Israel's foreign trade. However, establishing a customs regime between Israel and the Palestinians would substantially damage some sectors of Israel's economy.

Security Fence – The establishment of a customs regime between Israel and the Palestinians is conditional upon the existence of a physical border between the two entities. While the fence in Gaza is already built, the completion of the Security Fence in the West Bank would take another year and half. Until then, it would be difficult to prevent smuggling of products such as medicine, liquor and cigarettes to Israel.

Leverage in Negotiations (1) – The Disengagement Plan created an inversion of positions in the economic sphere regarding the Customs Envelope arrangement in Gaza and the West Bank:

  1. In the Past, based on the political logic of the Oslo Process, Israel demanded the preservation of the Customs Envelope in both Gaza and the West Bank. The Palestinians objected, and demanded economic independence;
  2. Currently, the Palestinians and the international community demand the preservation of the Customs Envelope in order to protect the Palestinian economy. The dismantling of the Customs Envelope should be done gradually and in accordance with the Palestinian revenue collection capacities;

Therefore, the preservation of the Customs Envelope became an Israeli leverage in the negotiations with the Palestinians and the international community.

Political Leverage (2) – Differentiation between Gaza and the West Bank / Excluding Gaza from the Customs Envelope – The principle of a unified regime in Gaza and the West Bank is a Palestinian interest deriving from the fundamental principle of the Oslo Process according to which Gaza and the West Bank are a Single Territorial Unit. However, the Disengagement has differentiated the political situation in Gaza from that of the West Bank.

This new reality allows Israel to differentiate Gaza from the West Bank by excluding Gaza from the Customs Envelope. Such a move serves as an Israeli leverage within the political process.

End of Responsibility – Ending Israel's economic responsibility towards the Palestinians is a necessary milestone on the path to ending Israel's overarching responsibility towards them. Levying customs and indirect taxes independently would be an attribute of Palestinian Sovereignty. Meanwhile, according to the Palestinians and the international community, Israel would not be able to revoke its responsibility over Gaza alone, unless it is a part of a combined settlement that includes the West Bank as well (All or Nothing Approach).

Political-Sovereign-Economic Status of the PA and the Establishment of the Palestinian State – Control over customs regime is a clear attribute of sovereignty. Hence, within the scope of ending Israel's responsibility, the Palestinians must either officially accept the Customs Envelope, sign a new agreement with Israel or establish an independent revenue collection mechanism. Each of these alternatives supports the process of building the PA's powers and authorities and advancing it towards statehood.

Policy Options

Israel's faces four alternatives with regards to the future of the Customs Envelope:

  1. Preserving the Customs Envelope in its current format, i.e. unified customs and indirect taxes regime in the West Bank, Gaza and Israel (with limited exceptions);
  2. Excluding Gaza from the Customs Envelope and preserving the Customs Envelope arrangement in Israel and the West Bank. This alternative matches the logic of ending Israel's responsibility over Gaza. However, the international community and the Palestinians will probably object to this exclusion, as it differentiates Gaza's economic status from that of the West Bank.
  3. Dismantling the Customs Envelope in both Gaza and the West Bank and establishing an alternative economic arrangement such as a Free Trade Zone. Such a regime would have to be established through an agreement with the Palestinians and may have to include arrangement for Safe Passage between Gaza and the West Bank.
  4. Dismantling the Customs Envelope through an Israeli move – either unilateral or coordinated with third parties – through the establishment of customs points along the line of the security fence. The passage of goods between Gaza, the West Bank and third parties would be subject only to security considerations. Additionally, Israel can grant the PA a Most Favored Nation status.

Israel citizens on the Palestinian side of the security fence – Once the security fence in the West Bank is completed, Israel could transfer the customs points to the security fence. At that point Israel would have to make special arrangements for tens of thousands of Israelis living east of the fence. Such arrangements are essential, especially with regards to products such as medicines, cigarettes and liquor.


1 A Fundamental Early Warning is a Re'ut Institute product whose aim is to reveal gaps between new trends and events, on the one hand, and primary assumptions of the Government of Israel (GOI), on the other hand. Failure to adjust to such gaps may lead Israel to a “Fundamental Surprise” which may expose its policy as not relevant. This paper attempts to highlight the working assumptions behind the policies of the GOI, indicate new trends and recommend policy options to close the relevancy gap.

2 The Paris Protocol (4/94) was attached as an Annex to the Gaza – Jericho Agreement (5/94) and the Interim Agreement (9/95).

3 See PM Rabin's instructions in Report of the Economic Advisory Teams to the Political Negotiations, July '93 (Hebrew)

4 The Interim Agreement stipulated further restrictions on the sovereignty of the PA. For details see Re'ut Institute Point of View: Is it Time to Upgrade the Political Status of the Palestinian Authority?

5 The 1978 Camp David Accords stipulated that Gaza and the West Bank are considered a "Single Territorial Unit". This principle was validated in the Declaration of Principles (9/93) and the Gaza – Jericho Agreement (5/94) signed between Israel and the PLO.

6 For details see Fundamental Early Warning: Palestinian State – Inversion of Positions.