evaluating the fiscal and social cost of fuel_wbenergyweek_v2

Evaluating the Fiscal and Social Cost of Fuel SubsidiesPoverty and Social Impact Analysis (PSIA) GroupFiscal Affairs DepartmentMarch 2006

Structure of PresentationBackground to PSIA on fuel subsidiesObjective of the PSIA studiesMethodology and data (five steps)Examples of policy responsesPolicy messages from PSIA

Background I: Market StructureMost developing countries control the domestic pricing and distribution of petroleum productsRecent FAD survey found that from 48 countries16 had fully liberalized systems9 had functioning automatic pricing formulae (+8 suspended recently)23 had ad hoc pricingLiberalized in Kenya, Tanzania, UgandaAutomatic in Ghana, Senegal, South Africa

Background II: Prices and SubsidiesWorld prices have increased >100% since 2000Controlled prices have resulted in rising budget subsidies in many countries (% 2005 GDP, projd.)Yemen, 9.2; Jordan, 6.6; Indonesia, 3.2; Bolivia, 0.8Subsidy rates typically higher for kerosene and diesel as well as in exporting countriesCountries often respond by decreasing taxation, so-called tax expenditures (especially kerosene and diesel)e.g. Bangladesh, India, Sri Lanka, Kenya, ZambiaImplicit subsidies also often substantial and take form of quasi-fiscal deficit financed by debt (%GDP2005, projd.)Azerbaijan, 9.9 (2.8ex); Egypt, 4.1; Ecuador, 3.6; Bolivia, 2.3

Crude oil prices,1970-2005 ($/bbl)

Background III: Reform AgendaFuel subsidies seen as undesirable becauseHigh fiscal cost with consequences elsewhere in budget (Indonesia: subsidies exceeded combined health and education budgets)Inefficient: leads to over-consumptionGovernments still reluctant to increase domestic prices in line with world pricesConcerns about impact on poor and politically unpopularPSIA can inform choice of appropriate policy response (so far: Bolivia, Ghana, Jordan, Mali, Sri Lanka...expected to increase!...Angola, Bangladesh, Cameroon, Ethiopia, Gabon, Honduras, Madagascar, Nicaragua, Nigeria)

Objective of PSIATo evaluate the social and fiscal cost of consumer subsidiesTo evaluate the aggregate and distributional incidence of their withdrawal on household real incomesTo identify appropriate mitigation measures to offset adverse impact on poorest households

Methodology and DataHigher domestic prices affect consumers through two channelsDirect effect from increase in price of fuels consumed by householdsIndirect effect from increase in prices of goods and services that use fuel as inputsIndirect effect often substantial since over 50 percent of total consumption of fuel is as intermediate product

Step I: Identify extent and locationThis requires a reference price for each product and required price increasesFor most countries, border (cif,fob) price (plus,minus) domestic trade and transport marginsOften existing or desired tax levels included in reference price to allow for tax expenditures

Fiscal and social cost of subsidiesDomestic refinery that imports productImport at P(m), produce at P(c)Subsidized domestic price is P(s)Produces Q(c), imports Q(s)-Q(c)Total consumer subsidy = (A+B+C)=Q(s)[P(m)-P(s)]Where shows up depends on price to producer. If taxes, P(p), P(s) Explicit import subsidy=(B+C) Loss in profits=(A+D)+ETax revenue=(D+E)Net fiscal positionOn budget: (D+E)-(B+C)Off budget: -(A+D+E)

Example from Ghana

Petrol

Kerosene

Diesel

Fuel Oil

LPG

World CIF price (F)

2,890

3,761

3,884

1,750

5,355

Total taxes (F)

1,711

1,342

1,811

1,141

1,543

Domestic margins

577

677

577

0

990

Ex-pump price (F)

5,179

5,780

5,940

2,891

7,888

Ex-pump price (A)

4,444

3,889

3,556

1,927

3,800

Required increase in current prices

17 percent

49 percent

67 percent

50 percent

108 percent

Note: Prices are in cedis per litre, except for LPG which is cedis per kg. A and F denote that prices are based on actual and formula levels, respectively. Ex-refinery price (F) is based on an average of Platt prices for OctoberDecember 2004, an exchange rate of c9,133.33 per US dollar and import margins at 13.8 percent of import CIF price. Included in taxes is an ad valorem excise set at 15 percent of the ex-refinery price.

Step II: Calculate direct effectNeed household survey with information on different fuel expendituresFor each household, calculate budget shares as expenditure on fuel divided by total household consumptionMultiply required price increases by budget share to get approx. real income impactLook at distribution of percentage real income effect across income groups (regressive vs. progressive)

Example from Ghana

Bottom

2nd

Quintile

3rd

Quintile

4th

Quintile

Top

All

Household Budget Shares

Petrol

0.001

0.001

0.002

0.002

0.021

0.006

Kerosene

0.059

0.041

0.034

0.024

0.016

0.035

LPGas

0

0

0

0.001

0.002

0.001

Real income effect( percentage change in consumption)

Direct effect

0.029

0.020

0.017

0.013

0.014

0.019

Indirect effect

0.062

0.066

0.067

0.069

0.068

0.067

Total effect

0.091

0.087

0.085

0.082

0.082

0.085

Indirect as percent of total

68 percent

77 percent

80 percent

84 percent

83 percent

80 percent

Share of the aggregate loss

Direct effect

0.135

0.160

0.180

0.193

0.332

1.000

Indirect effect

0.077

0.137

0.184

0.256

0.346

1.000

Total effect

0.088

0.142

0.184

0.244

0.343

1.000

Mean consumption

(Ratio to bottom quintile)

1.00

1.76

2.55

3.80

7.48

3.31

Step III: Calculate indirect effectAn input-output table and a simple model can be used to calculate the increase in prices for other goods and services from higher fuel costsAggregate household consumption data to get budget shares for input-output sectorsMultiply budget shares by percentage price increases to get percentage real income effectAggregate to get total indirect effect and look at distribution across different income groupsAdd to direct effect to get total impact of fuel price increase on household real incomes and distribution

Example from Ghana

Sector

Budget Share

(BS)

Price Effect

(dP)

Impact=BS*dP

Agriculture

0.452

0.066

0.030

Utilities and mining

0.021

0.116

0.002

Manufacturing

0.253

0.052

0.013

Construction

0.000

0.107

0.000

Trade

0.070

0.107

0.007

Transport

0.032

0.267

0.008

Business

0.025

0.025

0.001

Community

0.097

0.048

0.005

Electricity

0.008

0.000

0.000

Example from Ghana

Bottom

2nd

Quintile

3rd

Quintile

4th

Quintile

Top

All


Petrol

0.001

0.001

0.002

0.002

0.021

0.006

Kerosene

0.059

0.041

0.034

0.024

0.016

0.035

LPGas

0

0

0

0.001

0.002

0.001


Direct effect

0.029

0.020

0.017

0.013

0.014

0.019

Indirect effect

0.062

0.066

0.067

0.069

0.068

0.067

Total effect

0.091

0.087

0.085

0.082

0.082

0.085


68 percent

77 percent

80 percent

84 percent

83 percent

80 percent


Direct effect

0.135

0.160

0.180

0.193

0.332

1.000

Indirect effect

0.077

0.137

0.184

0.256

0.346

1.000

Total effect

0.088

0.142

0.184

0.244

0.343

1.000

Mean consumption


1.00

1.76

2.55

3.80

7.48

3.31

Step IV: Evaluate targeting efficiency Calculate the share of the total subsidy (or, equivalently, the burden of subsidy removal) accruing to each income groupCan do this separately for each product as well as the direct, indirect and total effectsIndividual product shares useful later when comparing alternative approaches to protecting the real incomes of low-income households

Example from Ghana

Bottom

2nd

Quintile

3rd

Quintile

4th

Quintile

Top

All


Petrol

0.001

0.001

0.002

0.002

0.021

0.006

Kerosene

0.059

0.041

0.034

0.024

0.016

0.035

LPGas

0

0

0

0.001

0.002

0.001


Direct effect

0.029

0.020

0.017

0.013

0.014

0.019

Indirect effect

0.062

0.066

0.067

0.069

0.068

0.067

Total effect

0.091

0.087

0.085

0.082

0.082

0.085


68 percent

77 percent

80 percent

84 percent

83 percent

80 percent


Direct effect

0.135

0.160

0.180

0.193

0.332

1.000

Indirect effect

0.077

0.137

0.184

0.256

0.346

1.000

Total effect

0.088

0.142

0.184

0.244

0.343

1.000

Mean consumption


1.00

1.76

2.55

3.80

7.48

3.31

Bolivia

Ghana

Jordan

Mali

Sri Lanka

Size of fuel subsidy

(% of 2004 GDP)

2.2 percent

2.2 percent

3.6 percent

2 percent

2.1 percent

Price increases

(simulated)

Raising prices world prices and LPG by 67 percent

Restoring a formula price that includes taxes

Eliminating subsidies and imposing a standard sales tax.

Raising oil prices by 34 percent

Raise average oil prices by 36.7 percent

Kerosene

49 percent

79.5 percent

34.0 percent

94 percent

LPG

67 percent

108 percent

47.5 percent

34.0 percent

n.a.

Diesel

40 percent

67 percent

77.1 percent

34.0 percent

40 percent

Gasoline

40 percent

17 percent

No change since tax>16%

34.0 percent

14 percent

Other

50 percent (Fuel Oil)

77-84 percent

34.0 percent

n.a

Total

50 percent?

50 percent

67.7 percent (excl. gasoline)

34.0 percent

36.7 percent

Aggregate real income impact

Direct

1.6 percent (neutral)

1.9 percent (very regressive)

2.0 percent (regressive)

0.85 percent (regressive, U)


Indirect


6.7 percent (slightly progressive)

2.4 percent (slightly progressive)


(1.06 if electricity incl.)

1.2 percent (neutral)

Total





(1.94 if electricity incl.)


Share of subsidy

( poorest 40 percent)

Direct

29.5 percent

22.9 percent

22.6 percent

27.2 percent

Indirect

21.4 percent

19.8 percent

24.4 percent

23.0 percent

Total

15.3 percent

23.0 percent

21.2 percent

23.9 percent

25.1 percent

Step V: Identify mitigating measuresCan consider a number of alternatives and simulate using household-level dataGradual withdrawal of specific fuel subsidies (kerosene, LPG) to minimize revenue-poverty trade-offUsing some of budgetary savings to finance targeted public expenditures (education, health, roads, transport, electricity)Restructure electricity tariff schedules to reduces cost for poorUse savings to finance existing/reformed/new social safety net for poorest households

Example from Ghana

Bottom

2nd

Quint

3rd

Quint

4th

Quint

Top

Benefit Shares

Education

Untargeted

0.215

0.225

0.219

0.187

0.154

Targeted

0.204

0.279

0.249

0.17

0.098

Health

Untargeted

0.149

0.193

0.208

0.207

0.244

Targeted

0.148

0.229

0.208

0.226

0.189

Rural electrification

0.329

0.251

0.212

0.135

0.074

Urban transport

0.299

0.128

0.185

0.28

0.376

Proxy-means targeting

0.373

0.277

0.205

0.111

0.347

Kerosene subsidy

0.178

0.211

0.227

0.209

0.174

Note: Quintiles are based on the national distribution of household consumption per adult equivalent

Example from Sri LankaSubsidy Coverage, Level, and Targeting Simulated Effect of Price Increases with Compensating Measures Real Income Impact of Electricity Tariff Subsidies Real Income Effects of Alternative Tariff Structures

Bottom2ndQuintile3rdQuintile4thQuintileTopAll Kerosene Subsidy Coverage0.7770.6890.6870.6180.4490.644Coverage Share 0.211 0.204 0.212 0.201 0.173 1.000Avg effect 0.0170.0110.0090.0070.0030.010Amount share 0.211 0.199 0.198 0.215 0.177 1.000

Samurdhi Food StampsCoverage 0.634 0.512 0.454 0.328 0.125 0.410Coverage Share 0.276 0.237 0.227 0.179 0.081 1.000Avg Effect0.0230.0130.0100.0060.0010.011Amount Share 0.287 0.241 0.233 0.173 0.065 1.000

Proxy Means Food StampsCoverage0.8250.5660.3950.2040.0330.405Coverage Share0.3910.2810.2030.1050.0201.000Avg Effect0.0330.0160.0090.0040.0000.012Amount Share0.3910.2810.2030.1050.0201.000

Bottom2ndQuintile3rdQuintile4thQuintileTopAllNo kerosene price increase Avg effect 0.0120.0140.0140.0150.0180.015Amount share 0.069 0.111 0.145 0.201 0.474 1.000

Samurdhi food stampsAvg Effect0.0070.0120.0130.0170.0200.014Amount Share 0.036 0.092 0.129 0.219 0.524 1.000

Proxy means uniform grantAvg Effect-0.0030.0090.0140.0190.0210.012Amount Share -0.011 0.075 0.142 0.250 0.544 1.000

Bottom2ndQuintile3rdQuintile4thQuintileTopAllReal income impact (Percent of consumption) Current Tariff Structure0.0120.0180.0190.0260.0320.022Simulation 1 0.0090.0130.0140.0200.0310.018Simulation 2 0.0130.0190.0180.0210.0200.019Simulation 3 0.0130.0180.0180.0200.0200.018Simulation 40.0130.0210.0200.0230.0190.020

Share of SubsidyCurrent Tariff Structure0.0480.1010.1280.2240.4991.000Simulation 1 0.0590.1200.1460.2350.4401.000Simulation 2 0.0700.1400.1650.2490.3761.000Simulation 3 0.0690.1310.1600.2330.4071.000Simulation 40.0770.1530.1780.2590.3331.000

Note: Total subsidies under the current tariff structure (see Table 7) are equivalent to 2.4 percent of total household consumption and 2.1 percent of GDP in 2004. The budget subsidies under each of the various simulations is reduced by 28percent compared to the existing subsidy total, i.e. to approximately 1.5 percent of GDP in 2004.

Mitigating Measures: GhanaIntroduced formula in January 2003 with 90 percent price increase. But formula abandoned and subsidies of 2.2% GDP2004February 2005 introduced new formula and set up National Petroleum Authority (broad stakeholder group) to depoliticize implementation. Prices increased in March/June/August/October 2005 and initial moves to liberalizing markets (import tendering)Announced range of mitigating expenditures (financed by mitigating levy in formula)Removal of fees for primary and junior secondary schoolIncreased investments in mass urban transportExpansion of rural electrification scheme

Mitigating Measures: JordanIn 2004 subsidy of 3.2 percent GDP, projected at 8.5 percent for 2005A 68 percent increase in prices (including taxes) needed to eliminate subsidiesPrice increases would lead to 4.4 percent reduction in real incomes (5.4% for bottom quintile)In July 2005 increased prices by over 25%, reducing subsidies to 3% annual basisIntroduced range of mitigating measuresRaised minimum wage and increased salaries for low-paid state employeesMaintained lifeline electricity tariffProvided one-time bonus to government employees and pensioners earning less than JD400/monthWill increase when targeting is improvedLPG, diesel, kerosene prices expected to reach import parity by March 2007 and intend to liberalize thereafter

Mitigating Measures: IndonesiaAd hoc system froze prices between 2002 and February 2005, when subsidies grew to gasoline (58%), diesel (60%) and kerosene (88%)Prices increased by 29% in March 2005 and planned increase of 30% in OctoberAnnounced 114% increase in October resulting in subsidies gasoline (20%), diesel (23%), kerosene (67%)Subsidies projected to be 3.2% GDP2005 and 1.8% in 2006Introduced unprecedented cash transfer program delivered through Post OfficeCoverage of 15.5 million poor families (60million persons)Each family to receive Rp.300,000 every 3 months (around US$30/mth)Annual cost estimated at RS.20 trillionAdditional incentive package also introduced

Policy messages from PSIAFuel subsidies are often substantial fiscal drain and badly targetedSo should be able to identify alternative approaches to social protection that provide same or better protection at substantially lower fiscal costAccess to effective system for targeting expenditures can be a crucial component for promoting efficiency-enhancing structural reformsImportant to announce reforms as part of a package where budgetary savings will be used to finance an effective safety net as well as expand social and infrastructure expenditures that benefit low- and middle-income householdsGradual reduction of better targeted fuel subsidies should be seen only as short term measure are developed since revenue-poverty trade off is large and efficiency cost from inter-fuel substitution largePSIA provides very useful approach for highlighting shortcomings of fuel subsidies and providing insights into alternative approaches for protecting the poor and reallocating expenditures

evaluating the fiscal and social cost of fuel_wbenergyweek_v2

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