In its decision today to withhold the further transfer of funds to the Hamas-led Palestinian Authority, the cabinet resolved a legal question that was pending since Hamas's electoral victory last month.
At that time, Israel was placed in a legal quandary which saw the government forced to decide between illegally funding a terrorist organization, or breeching previous agreements signed with the Palestinian Liberation Organization which mandate the monthly transfer of tax revenue Israel collects on behalf of the PA.
While the 1994 Paris Protocol established a customs union between Israel and the PA, it also arranged for the PA to be able to collect tax revenue as would any normal government. However, since the PA did not have the necessary infrastructure or expertise to collect its own taxes, the protocol established a "revenue clearance mechanism." Under that scheme, Israel collected all duties on behalf of the PA and was obliged to transfer the money to it the following month.
Aside from an extended period during the second intifada, Israel has until now transferred that money to the PA according to the agreement.
While halting the transfer of funds means Israel is technically in breech of the accords, Foreign Ministry spokesman Mark Regev said that by declaring their intentions to ignore some of the PA's signed agreements with Israel, it was Hamas which legally ended the arrangement.
"The transfer of money is a bilateral agreement," Regev said. "The incoming Hamas government said all these agreements are null and void. So they can't say that all the agreements are null and void, but this one point you have to keep unilaterally."
Regev pointed out that Israel is not confiscating the money, but rather holding it in escrow in an interest-bearing account until the day comes when Hamas meets the three conditions Israel has set out for negotiations, or a new party assumes power in the PLC.
The tax agreement between Israel and the PA includes all forms of duties.
Palestinian import and export tariffs are collected by Israel at the point of entry and exit for goods, while businesses employing Palestinian laborers pay their employee income taxes to the PA tax revenue fund.
The decision for Israel to collect the PA tax revenue was made for a number of logistical reasons, chief among them that the PA did not feel like it could trust its own tax collectors, said Eran Shayshon, an analyst for the Re'ut think tank in Tel Aviv. Israel also wanted the PA to remain, in many respects, a non-government, and it thus retained many governmental duties relating to the Palestinians for itself, he said.
Though ending the transfer of funds to the PA was a big step, the cabinet decided to employ only a small part of the economic leverage Israel has over the Palestinians.
In addition to the tax arrangements, the Paris Protocols created a customs union between Israel and the PA which harmonized the tax structure between the two, but more importantly, allows for goods to move from Israel to PA areas and vice versa without being taxed.
While withholding the tax revenue from the PA may make governing more difficult for Hamas in the short run, it is ultimately expected to be able to replace that revenue with funding from Arab countries. On the other hand, were Israel to dissolve the customs union and begin to levy taxes on every-day items Palestinians buy from Israel, as well as on the produce Palestinians sell to Israelis, the economic consequences for the Palestinians could be severe, said Jonathan Lipow, chief economist of Forum FIE, a financial consulting group in Ra'anana. However, such taxes would also adversely affect the Israeli economy, Lipow said, and thus any such move should be carefully considered.