Broad-based subsidies or targeted transfers? Distributional equity vs macroeconomic costs

ABSTRACT

We study the trade-off between “broad-based energy subsidy” and “subsidy reform and targeted transfer” in the developing country context. We analyze the incidence of an electricity tariff differential subsidy program in Pakistan and find that the greater share of subsidy benefit goes to relatively non-poor households. We then conduct a computable general equilibrium exercise of electricity subsidy reform and targeted transfer, and our results indicate that redistributing savings from electricity subsidy reform improves poor households’ real income. However, this comes at the cost of short-term economic slowdown, before the economy returns to the benchmark level in the long term.

KEYWORDS:

• Electricity subsidy
• subsidy reform
• government transfer
• macroeconomic outlook
• computable general equilibrium

Disclosure statement

No potential conflict of interest.

Supplementary material

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Notes

1. They analyze the scenario where monthly benefit of Benazir Income Support Programme (BISP) is increased by Rs. 300.

2. Among the eleven distribution companies in Pakistan, five are located in Punjab, three in Sindh, one in Balochistan, and two in Khyber Pakhtunkhwa. Cost-recovery tariffs vary across regions based on geographic location, proportion of urban and rural consumers, etc.

3. Residential consumers consuming 1 to 50 kWh of electricity are considered as ``Life-line Consumers” and pays a minimal tariff of Rs. 2.00 per kWh.

4. There is a general sales tax (GST) of 16% on electricity consumption.

5. Agents form expectations based on weighted average of historical prices, and agents’ past errors in predicting those prices (Feltenstein and Cyan 2013).

6. The size of informal economy is more than 30% of GDP in Pakistan (Gulzar, Junaid, and Haider 2010).

7. The sectors are – i) Light Manufacturing, ii) Heavy Industry, iii) Electricity, Water, and Sewage, iv) Transport, and v) Hotels, Housing, and Health Services.

8. Urban consumer categories are: i) Urban Quintile 1, ii) Urban Quintile 2, and iii) Urban Other.

9. Rural consumer categories are: i) Landless Farmer Sindh, ii) Landless Farmer Punjab iii) Landless Farmer Other Pakistan, iv) Waged Rural Landless Farmers Sindh, v) Waged Rural Landless Farmers Punjab, vi) Waged Rural Landless Farmers Other Pakistan, vii) Small Farm Sindh, viii) Small Farm Punjab, ix) Small Farm Other Pakistan, x) Medium Farm Sindh, xi) Medium Farm Punjab, xii) Medium Farm Other Pakistan, xiii) Rural Non-farm Quintile 1, xiv) Rural Non-farm Quintile 2, and xv) Rural Non-farm Other.

10. The capital tax in the model is equivalent to the corporate income tax. However, the production functions are constant returns to scale, and, hence, the capital tax here is a tax on returns to capital. Units of domestic currency per unit of foreign currency.

Additional information

Funding

No funding was received for this research.