Subsidy structuring

Wednesday, 16 May 2018 00:00 - - {{hitsCtrl.values.hits}}

The recent fuel price increase has re-focused the spotlight on Government subsidies and how they can be best structured by policymakers to help the people that need them the most. It gives an interesting insight on how taxpayer-funded assistance is viewed by different stakeholders and how engagement should happen to provide social equity.

It is a commonly-accepted fact that general subsidies not only cost more taxpayer money but are often broad-based to benefit the rich as well as the poor. When it comes to subsidies such as fuel, the deciding factor is the level of consumption and as such affect rich, middle income and poor people in different ways.

The fuel subsidy cost the taxpayer about Rs. 35 billion in 2017, which is on par with the fertiliser subsidy and higher than Samurdhi. With the likelihood of global prices increasing even further in 2018 due to various factors such as the US pulling out of the Iran nuclear deal and supply bottlenecks a transparent pricing formula seemed the inevitable conclusion, especially given the high debt of the Ceylon Petroleum Corporation (CPC).

It is true that better management of the CPC, preventing spot tenders and improving overall efficiency and planning of the power sector that also consumes significant amounts of fuel could have helped the Government stave off an increase. But given that the Government has struggled to put its house in order regarding large loss-making State-Owned Enterprises (SOEs) a price hike seemed the only choice.

According to Finance Ministry calculations based on Sri Lanka’s 2016 Household Income and Expenditure Survey the richest 20% of society consumed 47% of the fuel and the richest 30% consumed 60% of the fuel. The poorest 10% of households consumed only 2% of the fuel sold, the next 10%, consumed 3% showing that the poorest 20% of society consumed only 5% of the fuel. The poorest 30% of households consumed only 10% of the fuel.

The trend holds the world over, as energy use goes up with incomes. Within countries also richer nations use more energy per person than less affluent ones. The rich use cars, travel more and in the case of electricity also they have bigger houses and may use air conditioning or washing machines.

As a result, energy taxes are progressive. Even those operating in a black economy pay taxes when they travel, which is the beauty of indirect taxes, unlike in the case of direct taxes like income tax which are avoided, according to analysts.

On the other hand, food taxes, especially import duties on basic foods, imposed to give extra profits to the farming lobby are regressive and hurt the poor the most because food consumption does not increase parallel to income rise. Therefore the critical element in structuring subsidies is to understand who gets affected and how and find way to help these people directly.

For such a system to be established the Government, public officials in particular have to work efficiently and be flexible in understanding and addressing grievances. This is the primary reason why transferring to direct cash methods as mooted by the Finance Ministry in giving a kerosene subsidy will be crucial as to how the rest of the population accepts the flexible fuel pricing scheme.