Why subsidies are bad.

by Ulrika Lomas, Tax-News.com, Brussels

29 March 2013

A new research paper, involving input from several International Monetary Fund departments, urges governments to pay attention to the substantial benefits that the worldwide reform of energy subsidies could have on nations' finances, income distribution, and the environment.

Subsidies amount to reverse taxation and are generally introduced with a view to protecting poorer consumers by keeping prices low. The IMF paper points out that energy subsidies are widely considered to be inefficient at protecting consumers in need, however, and should be better targeted.

Drawing on the report's findings, Carlo Cottarelli, Director of the IMF’s Fiscal Affairs Department, said: "Subsidies are a problem in practically every country in the world. Even where countries impose taxes on energy, they’re rarely high enough to account for all of the adverse effects of excessive energy consumption, including on the environment. Based on a new database for 176 countries, we estimate that subsidies in 2011 amounted to USD1.9 trillion, the equivalent of about 2.5% of world GDP, or 8% of all government revenues."

"Since energy subsidies are pervasive and costly for governments to maintain, we see scope for reform not only in emerging market and developing countries, but also in advanced economies. The top three subsidizers across the world are the United States at USD502bn, China at USD279bn, and Russia at USD116bn. Clearly, when a country embarks on subsidy reform, there is a need to be mindful of possible adverse effects on the poor, and mitigating measures to protect the poor have to be built into the reform plan. This applies to all countries."

"Subsidies are expensive and ultimately must be paid by someone. This is of course true for any spending but there are several problems that are specific to energy subsidies. First, they are a very inefficient way of supporting the poor, as the rich consume more energy than the poor and therefore receive most of the benefits of the subsidies. In fact, on average, the richest 20% of households in low- and middle-income countries capture six times more in fuel subsidies than the poorest 20%. Governments, therefore, should make better use of the scarce ammunition in their fiscal arsenal for programs that more directly help the poor."

IMF First Deputy Managing Director David Lipton pointed out that the benefits of energy subsidy reform go beyond helping the poor. He noted the study's findings that eliminating pre-tax subsidies would reduce global carbon dioxide emissions by about 1-2% which would, by itself, represent “a significant first step in reducing emissions by delivering about 15-30% of the Copenhagen Accord’s goal.” As for advanced economies, he noted that subsidies most often take the form of taxes that are too low to capture the true costs to society of energy use (tax subsidies), including pollution and road congestion. “Eliminating energy tax subsidies would deliver even more significant emissions reductions," said Lipton, slashing CO2 emissions by 4½ billion tons – a 13% reduction.