A recent working paper of the IMF shows that many countries subsidize the consumption of fuels,however the study shows that fuel subsidies are fiscally costly and socially regressive.
At a global level, a major cross-country study by the IMF showed that fuel subsidies generally crowd out high priority public spending, like health, education and infrastructure. They also put pressure on current account deficits, distort productive investment toward energy-intensive sectors and technologies, and contribute to global warming. Fuel subsidies are the opposite of carbon taxes, after all. But the study also showed that fuel subsidies are regressive, meaning that they actually benefit the rich much more than the poor.
Averaged across a large number of low-and middle-income countries, the study found that the top 20% of households capture six times more in benefits from fuel subsidies than the poorest 20%. Why? Because upper income households consume a lot more fuel products than poor ones, especially gasoline, which is the most regressive fuel product to subsidize. The image of a millionaire zooming by in his big SUV comes to mind. By contrast kerosene, which poor families are more likely to consume, is the least regressive product to subsidize.
Recognizing that fuel subsidies were reaching the neighborhood of 2% of GDP, and crowding out more productive public spending, India’s government has taken bold steps over the past nine months to reduce fuel subsidies. Diesel prices have systematically been rising, there are plans to cap the number of subsidized Liquefied Petroleum Gas cylinders per household, and state electricity boards have been encouraged to set more cost-reflective power tariffs. These measures are welcome, as they also help to take pressure off the worsening current account deficit.
But what less widely understood is that reducing fuel subsidies is a pro-poor measure. In per capita terms, the top 10% of Indian households spends more than 20 times as much on fuel as the poorest 10%. This includes both direct and indirect consumption – the latter being when producers transport food to market, for example, using subsidized fuel. Low-income households consume mainly kerosene, while upper income households predominantly use petrol and LPG.
The bottom 40% of families could be fully compensated for the move to market prices for less than a fifth of what government now spends on fuel subsidies, leaving significant savings to invest in roads, schools, and hospitals.
