## _090808a ## Source details **Canonical URL:** [_090808a](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2008/_090808a.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2008/_090808a.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2008/_090808a.pdf.json) --- ### Executive summary — overview and scope - Government price subsidies are pervasive in developed, emerging, and low-income countries. - Definition used: a subsidy is a form of government intervention resulting in a deviation of an actual price facing consumers and producers from a specified benchmark price. - Focus: subsidies for fossil fuels and selected food commodities, with emphasis on measurement using a uniform methodology for traded fuels. - Key policy themes: - Pass through international prices to domestic prices to promote efficiency and mitigate balance-of-payments effects and negative externalities (adjustments may be gradual). - Rein in fiscal costs of subsidies, especially when required by macro-fiscal considerations. - Protect the poor and other vulnerable groups from the impact of rising prices. ### Recent developments and empirical findings (summary) - Countries largely passed through price increases through end-2006, but the substantial rise in international prices since then curtailed this trend. - As of end-2007: - Roughly one-fifth of the countries for which data are available were subsidizing gasoline. - Slightly more than one-third were subsidizing diesel. - Nineteen of the 25 countries that subsidized aggregate consumption of gasoline and diesel are oil exporters. - Almost one-third of the countries either had increased or were planning to increase fuel subsidies during 2008. - Food policy responses, 2006–2008: - Food taxes were reduced between 2006 and 2008 in more than one-half of the countries for which data are available. - Most tax decreases involved reducing import duties rather than VAT or consumption taxes. - More than two-thirds of tax cuts in low and middle-income countries occurred in the last five months, with 45 countries decreasing taxes in 2008. - Twenty-two countries increased food subsidies. - Fiscal cost of these policy measures is substantial and likely to increase. ### Conceptual and measurement approach - Benchmarks: - For internationally traded goods: marginal supply cost benchmark = international prices adjusted for transportation, distribution, and marketing costs. - For non-traded goods: benchmark = marginal production cost. - Measurement caveats: - Consumption subsidies measured relative to marginal cost will underestimate full subsidies whenever optimal taxes are positive; sensitivity analysis includes assumed optimal taxation. - Not all subsidies appear as budget outlays: direct budgetary outlays, reduced tax rates, losses of state-owned enterprises, and regulatory cross-subsidies need transparent reporting. ### Fossil-fuel subsidies — key statistics and pass-through - Fossil fuels accounted for almost 90 percent of the world’s primary fuel consumption in 2007: - Oil and oil derivatives accounted for about one-third. - Coal for about one-quarter. - Natural gas for about one-quarter. - Average annual rate of nominal US$ price change, December 2003 to July 2008 (In percent): - Spot crude: 30.5 - Natural gas: 20.6 - Coal: 33.7 - Total fuels: 29.6 - Average annual rate of price change, end-2003 to June 2008 (In percent): - Gasoline: 29.7 - Diesel: 34.1 - Kerosene: 33.6 - Median cumulative pass-through, end-2003 to end-2007 (in percent) across sample: - Gasoline: 103 - Diesel: 86 - Kerosene: 68 - Median pass-through patterns (end-2003 to end-2007, country medians): - Gasoline: 2004: 18; 2005: 21; 2006: 14; 2007: 13; 10 - Diesel: 2004: 8; 2005: 8; 2006: 9; 2007: 5; 8 - Kerosene: 2004: 8; 2005: 2; 2006: 9; 2007: 2; 6 - Weighted average domestic retail prices, end-2007 (US$ per liter): - All Countries: Gasoline 1.00; Diesel 1.08; Kerosene 0.57 - Importers: Gasoline 1.05; Diesel 1.15; Kerosene 0.61 - Exporters: Gasoline 0.75; Diesel 0.73; Kerosene 0.25 - Average world hub price: Gasoline 0.61; Diesel 0.69; Kerosene 0.69 ### Price subsidy and tax incidence (end-2007) — headline findings - Sample sizes: Gasoline 93 countries; Diesel 93 countries; Kerosene 39 countries. - Share of countries subsidizing (narrow sense, retail below benchmark): - Gasoline: roughly one-fifth (19 of 93). - Diesel: slightly more than one-third (32 of 93). - Kerosene: more than two-thirds (27 of 39). - Under assumption of uniform optimal tax US$0.30 per liter for gasoline and US$0.28 for diesel: - Gasoline: subsidizing countries increase to almost 45 percent. - Diesel: subsidizing countries increase to almost 60 percent. - Consumption shares of subsidized products (narrow sense): - Gasoline: subsidizing countries accounted for 12 percent of total gasoline consumption. - Diesel: subsidizing countries accounted for one-third of diesel consumption. - Kerosene: virtually all consumption was subsidized. - Weighted average net tax (all countries): - Gasoline: US$0.30 per liter (43 percent of weighted average before-tax price). - Diesel: US$0.28 per liter (36 percent of weighted average before-tax price). - Table 4 highlights (end-2007, preserved figures): - Gasoline (Countries with taxes = 74; Countries with subsidies = 19; All countries = 93) - Average price (US$): taxes 1.06; subsidies 0.32; all 1.00 - Average net tax (US$): taxes 0.36; subsidies -0.34; all 0.30 - Aggregate net tax rate (percent): taxes 51; subsidies -52; all 43 - Percent of consumption: taxes 88; subsidies 12; all 100 - Diesel (Countries with taxes = 61; Countries with subsidies = 32; All = 93) - Average price (US$): taxes 1.32; subsidies 0.55; all 1.08 - Average net tax (US$): taxes 0.52; subsidies -0.23; all 0.28 - Aggregate net tax rate (percent): taxes 65; subsidies -30; all 36 - Percent of consumption: taxes 69; subsidies 31; all 100 - Kerosene (Countries with taxes = 12; Countries with subsidies = 27; All = 39) - Average price (US$): taxes 0.84; subsidies 0.56; all 0.57 - Average net tax (US$): taxes 0.09; subsidies -0.22; all -0.21 - Aggregate net tax rate (percent): taxes 12; subsidies -28; all -27 - Percent of consumption: taxes 4; subsidies 96; all 100 ### Distributional, fiscal, and international spillovers - Aggregate net tax rates and fiscal incidence (selected entries from Table 5, preserved numbers): - High income OECD: gasoline aggregate net tax rate 57.4 (percent); net tax as percent of GDP (gasoline) 0.73; total gasoline & diesel net tax as percent of GDP 1.76. - Upper middle income: gasoline aggregate net tax rate 47.2; net tax as percent of GDP 0.79. - Lower middle income: gasoline aggregate net tax rate -6.8; net tax as percent of GDP (gasoline) -0.14; diesel aggregate net tax rate -25.8; net tax as percent of GDP (diesel) -1.11. - Importer: gasoline aggregate net tax rate 47.0; net tax as percent of GDP 0.67; total net tax share 92.4. - Exporter: gasoline aggregate net tax rate 21.0; net tax as percent of GDP 0.31; total net tax share 7.6. - Extreme negative net tax rates observed: - Down to -91 percent for gasoline and -97 percent for diesel. - Fourteen countries have net tax rates lower than -25 percent for gasoline. - Twenty-one countries have net tax rates lower than -25 percent for diesel. - Almost all deep-subsidy countries are oil exporters. - Targeting: IMF review of country studies found that, on average, over 80 percent of the benefits of fuel subsidies (assuming a uniform subsidy across different products) went to the top three income quintiles. - Sensitivity to alternative optimal tax (US$0.50 per liter assumption): - Current pricing implies average tax subsidies of Gasoline US$0.20 per liter; Diesel US$0.22 per liter. - Under that assumption, seventy percent of total net subsidy accrues to lower middle-income countries, and total subsidies are almost 1 percent of total GDP. ### Policy responses observed and fiscal costs (2008) - IMF survey (June 2008): 25 of the 159 countries surveyed report having reduced or planning to reduce revenue from fuel taxes in 2008. - For the 26 countries that report subsidy increases for 2008, the median fiscal cost is 0.6 percent of GDP. - Countries with large fiscal responses (increase in fiscal cost > 0.5 pct of GDP, selected): - Ecuador: Subsidy increase 2.3; Total cost 2.3 (percent of GDP) - Yemen, Republic of: 2.2 - Morocco: 2.1 - Venezuela, Rep. Bol.: 2.0 - Pakistan: 2.0 - India: 1.2 - Mexico: 0.6 - Korea, Republic of: Tax reduction 0.5; Total cost 0.5 - Note: Survey fiscal cost estimates use different methods/data than comprehensive subsidy estimates elsewhere. ### Food subsidies, price surge, and fiscal impacts - Food price dynamics: - Prices of cereals and vegetable oils increased at an annual rate of about 50 percent between end-2006 and May 2008. - Price increase for food exports measured in euros is slightly more than half the increase measured in U.S. dollars. - Short-term GDP impact of cereal price doubling: - Median impact: -0.9 percent of GDP for net importers and 0.5 percent for net exporters. - One-quarter of cereal importers have a loss exceeding 1.4 percent of GDP; five have a loss greater than 5 percent of GDP. - Policy responses observed (IMF survey 2008a): - Food taxes reduced in 84 countries between 2006 and 2008; most reductions in import duties (76 countries) rather than VAT (22 countries). - Twenty-two countries increased food subsidies; six reduced subsidies. - At least 30 countries imposed export restrictions or bans on agricultural commodities, especially rice. - Fiscal cost of food policy responses: - Cost of tax and tariff reductions ranged up to 1.1 percent of GDP in the 31 countries reducing taxes; fiscal cost was over 0.5 percent of GDP in eight countries. - Subsidy increases were more costly: 22 countries incurred fiscal costs by increasing food subsidies in 2007 or 2008. - Fiscal cost exceeded 1 percent of GDP in 6 countries and 0.5 percent in another 5 countries. - Countries with subsidies greater than 0.5 percent of GDP, 2008 (In percent of GDP, selected): - Maldives: Increase (2007 to 2008) 2.9; Total subsidies (2008) 3.6 - Burundi: 0.6; 2.5 - Timor-Leste: 1.5; 2.3 - Egypt: 0.3; 1.8 - Jordan: -0.1; 1.7 - Morocco: 0.2; 1.2 - India: 0.1; 0.7 ### Distributional and targeting implications for food and fuel subsidies - Food budget shares: - Average household food budget share: around 40 percent in middle-income countries and around 65 percent in low-income countries. - Food budget shares are substantially higher for lower income groups; burden of food price increases is highly regressive. - Country evidence on regressivity: - Senegal: around 64 percent of the subsidy for rice went to the top three income quintiles. - Madagascar: nearly 75 percent of the benefits of lower rice prices went to the top three deciles. - Empirical estimates of welfare impacts from price changes: - Ivanic and Martin (2008): first-order welfare effects from commodity price increases between 2005 and 2007 led to an estimated increase, ceteris paribus, of 4.5 percent in poverty rates (poverty line US$1/day). ### Reform options, sequencing, and implementation lessons - When rapid implementation of sophisticated targeted safety nets is not feasible, governments can: - Raise prices of goods primarily consumed by the poor (for instance, cereals and kerosene) more gradually than other prices. - Identify a package of short-term measures to mitigate adverse impact using existing programs (school meals; reductions in education and health user fees; subsidized mass urban transport; cash transfers; subsidized water and electricity below thresholds). - Use savings from subsidy reform to increase public spending that benefits poor households (education, health, infrastructure). - Improve targeting using categorical or geographical targeting, self-targeting work programs, or schooling requirements. - Box 1: lessons from price-subsidy reform (selected lessons preserved): 1. Appropriate speed of reform should be case-by-case; rapid reform preferable if protection mechanisms can be established quickly. 2. Compensation schemes should be temporary and replaced with formal social policy instruments. 3. Perfect targeting does not exist; self-targeting often the only feasible option. 4. Targeting by household characteristics can be relatively efficient when income data are weak. 5. A general subsidy limited to the amount consumed by the poor protects poor households while generating budgetary savings. 6. Political risks can be reduced by public explanation and by avoiding undue burden on a single group. - Country examples of mitigating measures: - Gabon, Ghana, Indonesia, Jordan implemented cash transfers, fee waivers, lifeline tariffs, school and health measures, transport investments, and targeted compensation programs. ### Pricing mechanisms, pass-through, and resilience - Reform of price-setting mechanisms is essential: - First-best: liberalize prices with supporting institutional arrangements. - If markets imperfect or price volatility worrying: implement automatic pricing mechanisms (moving averages, price adjustment caps/triggers, price bands). - Empirical observation: countries with automatic pricing formulas and liberalized pricing have substantially higher tax rates than countries with ad hoc price adjustments. - Pass-through measurement (definition preserved): - P = (|q110 − q10|) / (|p110 e110 − p10 e10|), where q_t domestic price, p_t international price at nearest hub (US$), e_t exchange rate local currency per US$; all nominal. - Sensitivity: pass-through estimates sensitive to start/end dates; high measured pass-through can reflect subsidy removal as well as pass-through of new international price changes. ### Externalities and multilateral dimensions - Environmental externalities: - Fossil fuels represent about two-thirds of current emission of GHGs. - Agriculture accounts for about 13 percent of such emissions; deforestation contributes approximately a further 18–20 percent. - Biofuels and food prices: - Biofuels production has contributed to higher corn and other crop prices; some biofuel forms increase GHGs when lifecycle effects and land conversion are considered. - Multilateral cooperation recommended: - International coordination of subsidy policies could be discussed in regional and multilateral surveillance to address global spillovers (climate change, trade distortions, export restrictions). - Fund and World Bank collaboration: Fund on macro/fiscal assessment and technical assistance; World Bank on safety-net design and understanding biofuels and trade implications. ### Measurement appendix — benchmarks and sensitivities - Benchmark for imports: international U.S. dollar price at nearest hub + US$0.07 per liter shipping + US$0.07 per liter domestic distribution/retailing = US$0.14 per liter additions for importers. - Sensitivity: an increase in transportation costs of US$0.01 per liter decreases estimated taxes or increases estimated subsidies by US$0.01 per liter in importing countries, and by US$0.02 per liter in exporting countries. - Nominal international prices of gasoline, diesel and kerosene increased by between 222.2 percent and 274.1 percent from end-2003 to mid-2008 (product cumulative increases preserved): - Gasoline cumulative increase: 222.2 - Diesel cumulative increase: 274.1 - Kerosene cumulative increase: 268.8 *Source: Executive Summary and chapters as provided in the content unit _090808a.* ### Executive Summary....................................................................................................... ### Executive Summary ### Overview of subsidies and scope of the paper - Government price subsidies are pervasive in developed, emerging, and low-income countries. - Definition used: a subsidy is a form of government intervention resulting in a deviation of an actual price facing consumers and producers from a specified benchmark price. - Subsidies affect consumption and production patterns, distribution of resources, the budget, expenditure composition, long-term growth, and can produce domestic, regional, or global spillovers. - The paper focuses on subsidies for fossil fuels and selected food commodities, with emphasis on measurement using a uniform methodology for traded fuels. ### Recent developments and empirical findings - Countries largely passed through price increases through end-2006, but the substantial rise in international prices since then has curtailed this trend. - As of end-2007: - Roughly one-fifth of the countries for which data are available were subsidizing gasoline. - Slightly more than one-third were subsidizing diesel. - Nineteen of the 25 countries that subsidized aggregate consumption of gasoline and diesel are oil exporters. - If countries with comparatively low taxation of such products (tax subsidies) were reclassified as subsidizing countries, the percentages and the sample of subsidizing countries would be significantly larger. - Country studies show that fuel subsidies are almost invariably badly targeted. - Almost one-third of the countries either had increased or were planning to increase fuel subsidies during 2008, with substantial fiscal costs. - Food policy responses, 2006–2008: - Food taxes were reduced between 2006 and 2008 in more than one-half of the countries for which data are available. - Most tax decreases involved reducing import duties rather than VAT or consumption taxes. - More than two-thirds of tax cuts in low and middle-income countries occurred in the last five months, with 45 countries decreasing taxes in 2008. - Twenty-two countries increased food subsidies. - The fiscal cost of these policy measures is substantial and is likely to increase. ### Conceptual and measurement points - Subsidy measurement approach: - For internationally traded goods, marginal supply cost benchmark is based on international prices adjusted for transportation, distribution, and marketing costs. - For non-traded goods, benchmark is marginal production cost. - Consumption subsidies measured relative to marginal cost will underestimate full subsidies whenever optimal taxes are positive; the paper provides sensitivity analysis including assumed optimal taxation. - Not all subsidies appear as budgetary outlays: - Direct budgetary outlays or reduced revenue show up in the budget (e.g., reduced tax rates, reimbursements). - Losses of state-owned enterprises selling below cost may be shared between enterprise and budget and should be reported transparently. - Regulatory cross-subsidies (e.g., export bans, mandated domestic prices) can create subsidies financed by producers without immediate fiscal entries—but should still be measured and reported. ### Central policy messages - Three major themes: - The importance of passing through international prices to domestic prices to promote efficiency, to mitigate balance-of-payments effects for net importers, and to reduce negative externalities—though adjustments may need to be gradual. - The need to rein in the fiscal costs of subsidies, especially when required by macro-fiscal considerations. - The need to protect the poor and other vulnerable groups from the impact of rising prices. ### Policy recommendations and reform options - Key policy recommendations include: 1. Passing through international prices to domestic prices to promote efficiency and to mitigate the impact on the balance of payments of net importers, as well as negative externalities, although the adjustment may have to be gradual. 2. Reining in the fiscal costs of subsidies, especially when required by macro-fiscal considerations. 3. Protecting the poor and other vulnerable groups from the impact of rising prices. - When rapid implementation of sophisticated targeted safety nets is not feasible, governments can: - Raise prices of goods primarily consumed by the poor (for instance, cereals and kerosene) more gradually than other prices. - Identify a package of short-term measures to mitigate the adverse impact of price increases on the poor. - Use some of the savings from subsidy reform to increase public spending that especially benefits poor households. - Use a range of methods to improve targeting of needy households, such as categorical or geographical targeting or linking benefits to a self-targeting work program or schooling requirement. - Successful reform should include steps toward building political support, including promoting transparency, educating the public, and assuring the public that savings from targeting will be used well. ### Implementation challenges and spillovers - Major obstacles to subsidy reform: - Poor understanding of subsidy costs and social impacts. - Vested interests resisting reform. - Absence of safety net programs and weak capacity to target the poor. - Tendency for subsidies to reemerge if prices are not adjusted regularly. - Cross-border spillovers and channels: - Lack of pass-through of international prices to domestic prices and export restrictions affect global demand. - Subsidies can exacerbate global or regional externalities such as climate change and other environmental risks. - Smuggling of subsidized items, pass-through of subsidies into export prices, and agricultural subsidies can cause spillovers. - For global and regional spillovers, international coordination of subsidy policies will be needed. - Pricing mechanism recommendations: - Liberalized and automatic pricing regimes facilitate full pass-through of changes in world prices. - Many countries have abandoned automatic pricing regimes when faced with increasing world prices; absent liberalized markets, develop pricing mechanisms resilient to price increases. *Source: Executive Summary (provided content).* ### 13. The economic impact of subsidies can be achieved in many ways. While consumer ### _090808a - 13. The economic impact of subsidies can be achieved in many ways. While consumer ### Economic impact and incidence of subsidies - Consumer subsidies are the most direct subsidization tools, but indirect forms exist (subsidizing capital or labor for producers; reduced tax rates and lowered bases for capital and labor) and can have equivalent price effects. - The impact of all subsidies should be transparently analyzed; a comprehensive social cost-benefit analysis is required to compare the economy with and without subsidies. - Incidence of subsidies is not purely domestic: - Global/regional externalities (for example, climate change or environmental risks) lead to spillovers among countries. - Large subsidized consumption can reduce supply to other countries and increase world prices. - Smuggling can cause residents of one country to pay for subsidies accruing to another country. - Domestic subsidies on intermediate inputs can be passed through to export prices. - Producer subsidies for agriculture, including biofuels subsidies, adversely affect supply and price of staple food items. - Measuring full economic costs is complex: costs accrue to consumers, producers, and the public sector and have efficiency and equity implications. The remainder of the paper focuses on deviations of prices from benchmark levels and abstracts from efficiency costs. ### Fossil fuel subsidies — overview and context - Petroleum product subsidies have increased recently as many countries did not fully pass through increases in world prices. - Prices substantially below marginal supply cost are prevalent in oil-exporting countries. - The rate of taxation varies dramatically among countries; taxes in some countries may fall below optimal levels. - Relevant spillovers arise from below-cost prices and insufficient taxation; fiscal cost of subsidies strains budgets. - Fossil fuels accounted for almost 90 percent of the world’s primary fuel consumption in 2007. - Oil and oil derivatives accounted for about one-third. - Coal for about one-quarter. - Natural gas for about one-quarter. - Average annual rate of nominal US$ price change, December 2003 to July 2008 (In percent): - Spot crude: 30.5 - Natural gas: 20.6 - Coal: 33.7 - Total fuels: 29.6 ### Oil and oil derivatives — distribution, price changes, and trade concentration - Rapid price increases have generated very large resource transfers among countries. - Trade concentration (2005): five largest exporters and importers accounted for over 50 percent of trade flows; largest ten accounted for over 75 percent. - Out of 190 countries with information: 46 net exporters, 133 net importers, 11 with no net trade during the year. - Average annual rate of price change, end-2003 to June 2008 (In percent): - Gasoline: 29.7 - Diesel: 34.1 - Kerosene: 33.6 - Impact of a doubling of oil and oil derivative prices (ratio of net exports to GDP determines cost as percent of GDP): - Median impact for exporters: 13.8 percent of GDP. - One-quarter of exporters: impact greater than 42 percent. - Five exporters: impact greater than 50 percent. - Median adverse impact for importers: 3.2 percent of GDP. - One-quarter of importers: impact greater than 5.2 percent. - Six importers: impact greater than 10 percent. - Large impacts primarily in European countries and small island economies. - Table 1 summary (2005, all countries = 179): - Importers: 133; Imports / GDP (median) = 3.246 - Exporters: 46; Exports / GDP (median) = 13.8 ### Pass-through of international prices to domestic consumers and retail price patterns - Pass-through defined as ratio of absolute change in domestic retail (tax-inclusive) price to absolute change in benchmark price. - Median cumulative pass-through, end-2003 to end-2007 (in percent) across sample: - Gasoline: 103 - Diesel: 86 - Kerosene: 68 - Number of countries in sample: - Gasoline: 90 - Diesel: 88 - Kerosene: 64 - Pass-through patterns: - Roughly one-quarter of countries failed to pass through even one-half of the price increase in gasoline and diesel. - Pass-through especially low in oil-exporting countries and in ad hoc pricing regimes. - Weighted average domestic retail prices, end-2007 (US$ per liter): - High income OECD: Gasoline 1.10, Diesel 1.37, Kerosene 0.70 - High income non-OECD: Gasoline 0.59, Diesel 0.82, Kerosene 0.15 - Upper middle income: Gasoline 0.98, Diesel 0.95, Kerosene 0.69 - Lower middle income: Gasoline 0.68, Diesel 0.59, Kerosene 0.21 - Low income: Gasoline 0.71, Diesel 0.23, Kerosene 0.55 - All Countries: Gasoline 1.00, Diesel 1.08, Kerosene 0.57 - Importers: Gasoline 1.05, Diesel 1.15, Kerosene 0.61 - Exporters: Gasoline 0.75, Diesel 0.73, Kerosene 0.25 - Number of countries: Gasoline 93, Diesel 93, Kerosene 39 - Average world hub price: Gasoline 0.61, Diesel 0.69, Kerosene 0.69 ### Price subsidies and tax/subsidy incidence at end-2007 - Method: compare retail prices for gasoline and diesel in 93 countries and kerosene in 39 countries to benchmark prices adjusted for transactions costs. - Positive difference (retail above benchmark) implies “net tax.” Negative difference implies subsidy in a narrow sense (not accounting for optimal taxation). Key findings at end-2007: - Share of countries subsidizing (narrow sense): - Gasoline: roughly one-fifth (19 of 93). - Diesel: slightly more than one-third (32 of 93). - Kerosene: more than two-thirds (27 of 39). - Under assumption of uniform optimal tax US$0.30 per liter for gasoline and US$0.28 for diesel (average tax levels reported in Table 4), subsidizing countries increase to: - Gasoline: almost 45 percent. - Diesel: almost 60 percent. - Consumption shares of subsidized products (narrow sense): - Gasoline: subsidizing countries accounted for only 12 percent of total gasoline consumption. - Diesel: subsidizing countries accounted for one-third of diesel consumption. - Kerosene: virtually all consumption was subsidized. - If uniform optimal tax equal to current average taxes, consumption classified as subsidized: - Gasoline: 56 percent. - Diesel: 45 percent. - Nineteen of 25 countries with combined subsidies on gasoline and diesel (narrow sense) are oil exporters. - Only 11 oil-exporting countries accrue positive tax revenue from gasoline and diesel (including three high-income OECD countries). - Weighted average net tax (all countries): - Gasoline: US$0.30 per liter (43 percent of weighted average before-tax price). - Diesel: US$0.28 per liter (36 percent of weighted average before-tax price). - Table 4 highlights (end-2007): - Gasoline: Countries with taxes = 74, Countries with subsidies = 19, All countries = 93 - Average price (US$): taxes 1.06; subsidies 0.32; all 1.00 - Average net tax (US$): taxes 0.36; subsidies -0.34; all 0.30 - Aggregate net tax rate (percent): taxes 51; subsidies -52; all 43 - Percent of consumption: taxes 88; subsidies 12; all 100 - Diesel: Countries with taxes = 61, Countries with subsidies = 32, All = 93 - Average price (US$): taxes 1.32; subsidies 0.55; all 1.08 - Average net tax (US$): taxes 0.52; subsidies -0.23; all 0.28 - Aggregate net tax rate (percent): taxes 65; subsidies -30; all 36 - Percent of consumption: taxes 69; subsidies 31; all 100 - Kerosene: Countries with taxes = 12, Countries with subsidies = 27, All = 39 - Average price (US$): taxes 0.84; subsidies 0.56; all 0.57 - Average net tax (US$): taxes 0.09; subsidies -0.22; all -0.21 - Aggregate net tax rate (percent): taxes 12; subsidies -28; all -27 - Percent of consumption: taxes 4; subsidies 96; all 100 ### Distributional, fiscal, and international spillover implications - Distribution across countries matters more than aggregate taxation unless optimal tax rates exceed 43 percent for gasoline and 36 percent for diesel. - Aggregate net tax rates for countries with taxes vs. subsidies (Table 4): - Gasoline: taxes 51 percent; subsidies -52 percent. - Diesel: taxes 65 percent; subsidies -30 percent. - Extreme negative net tax rates observed: down to -91 percent for gasoline and -97 percent for diesel. - Fourteen countries have net tax rates lower than -25 percent for gasoline. - Twenty-one countries have net tax rates lower than -25 percent for diesel. - Almost all deep-subsidy countries are oil exporters. - Subsidies increase incentives for smuggling and corruption (diversion of subsidies away from consumers). - Reducing subsidies in oil-exporting countries could reduce world prices to the extent domestic consumption reductions are exported; effect limited by small share of consumption in these countries and possibility production adjustments. - Increasing taxes in several large-consumption countries (examples in text: China, Mexico, and perhaps the United States) would likely have larger spillover effects on world prices than reductions in small oil-exporter subsidies. - Countries with high tax rates create positive spillovers by reducing aggregate demand; tax rates range up to over 400 percent for gasoline and 300 percent for diesel. ### Net tax shares and fiscal incidence by income level and exporter status (end-2007) - Aggregate net tax rates, net tax as percent of GDP, and total net tax share (selected entries from Table 5): - High income OECD: - Aggregate net tax rate (gasoline): 57.4 (percent) - Net tax as a percent of GDP (gasoline): 0.73 - Total net tax share (gasoline): 88.2 - Aggregate net tax rate (diesel): 71.7 - Net tax as a percent of GDP (diesel): 1.03 - Total net tax share (diesel): 111.4 - Aggregate net tax rate (kerosene): -9.5 - Net tax as a percent of GDP (kerosene): -0.02 - Total net tax share (kerosene): 23.6 - Total gasoline & diesel: Net tax as a percent of GDP: 1.76; Total net tax share: 100.5 - Upper middle income: - Aggregate net tax rate (gasoline): 47.2; Net tax as percent of GDP: 0.79; Total net tax share: 14.6 - Aggregate net tax rate (diesel): 24.7; Net tax as percent of GDP: 0.54; Total net tax share: 9.0 - Aggregate net tax rate (kerosene): -4.4; Net tax as percent of GDP: 0.00; Total net tax share: 0.5 - Total gasoline & diesel: Net tax as percent of GDP: 1.33; Total net tax share: 11.6 - Lower middle income: - Aggregate net tax rate (gasoline): -6.8; Net tax as percent of GDP: -0.14; Total net tax share: -2.8 - Aggregate net tax rate (diesel): -25.8; Net tax as percent of GDP: -1.11; Total net tax share: -20.0 - Aggregate net tax rate (kerosene): -73.9; Net tax as percent of GDP: -0.33; Total net tax share: 72.3 - Total gasoline & diesel: Net tax as percent of GDP: -1.24; Total net tax share: -11.9 - Importer vs. Exporter (total): - Importer aggregate net tax rate (gasoline): 47.0; Net tax as percent of GDP: 0.67; Total net tax share: 92.4 - Exporter aggregate net tax rate (gasoline): 21.0; Net tax as percent of GDP: 0.31; Total net tax share: 7.6 - Total (all countries): gasoline aggregate net tax rate: 42.9; Net tax as percent of GDP: 0.61; Total net tax share: 100.0 - Diesel aggregate net tax rate (all countries): 35.9; Net tax as percent of GDP: 0.68; Total net tax share: 100.0 - Kerosene aggregate net tax rate (all countries): -26.9; Net tax as percent of GDP: -0.1; Total net tax share: 100.0 - Memorandum: Number of countries: Gasoline 93; Diesel 93; Kerosene 39 ### Sensitivity to assumed optimal tax and distributional targeting - If optimal tax on gasoline and diesel assumed to be US$0.50 per liter (instead of US$0.30 and US$0.28), current pricing implies average tax subsidies of: - Gasoline: US$0.20 per liter. - Diesel: US$0.22 per liter. - Under that alternative optimal tax assumption, total net subsidy distribution shifts; seventy percent of total net subsidy accrues to lower middle-income countries, and total subsidies are almost 1 percent of total GDP. - Fuel subsidies are almost invariably poorly targeted: - Subsidy amounts increase with income because higher-income households consume larger quantities of fuel products. - IMF review of country studies found that, on average, over 80 percent of the benefits of fuel subsidies (assuming a uniform subsidy across different products) went to the top three income quintiles. *Source: IMF staff estimates and analysis as presented in the supplied content.* ### 0.0 to 30.0 ### 0.0 to 30.0 (Content unit) ### Policy responses to petroleum price surge (2008) - In the IMF survey of policy responses (planned and implemented as of June 2008), 25 of the 159 countries surveyed report having reduced or planning to reduce revenue from fuel taxes in 2008. - For the 26 countries that report subsidy increases for 2008, the median fiscal cost is 0.6 percent of GDP. - Table 7 (pattern of fuel tax decreases by tax and country characteristics, 2008) summaries (counts reported in IMF (2008a)): - All Countries: 159 countries; Countries w/changes by tax category: Import 148, VAT 80, Sales 10, Excise 25, Income 16. - By income group (counts of countries with changes): High-income OECD 18; High-income non-OECD 15; Upper-middle income 34; Lower-middle income 43; Low-income 49. - Net oil trade balance: Importer 90; Exporter 69. - Observations: - Some countries reduced only import tariffs; these can be efficiency-enhancing if tariffs distort trade patterns but, when tariffs function as broad-based consumption taxes, their reduction should be viewed as a tax subsidy increase. - Reductions in consumption taxes can be considered as increases in tax subsidies, unless they correct pre-existing tax distortions. - Almost all reported tax reductions occurred in importing countries and represent measures to limit pass-through of world price increases. ### Fiscal costs and large fiscal responses (petroleum) - Table 8 lists countries with large fiscal responses in 2008 (tax reductions, subsidy increases, total cost; fiscal cost in percent of GDP): - Increase in fiscal cost > 0.5 pct of GDP: - Ecuador: Tax reduction 0.0; Subsidy increase 2.3; Total cost 2.3 - Yemen, Republic of: 0.0; 2.2; 2.2 - Morocco: 0.0; 2.1; 2.1 - Venezuela, Rep. Bol.: 0.0; 2.0; 2.0 - Pakistan: 0.0; 2.0; 2.0 - Malaysia: 0.0; 1.3; 1.3 - Ukraine: 0.0; 1.2; 1.2 - Peru: 0.4; 0.8; 1.2 - India: 0.0; 1.2; 1.2 - Egypt: 0.1; 1.1; 1.1 - Seychelles: 1.0; 0.0; 1.0 - Cameroon: 0.0; 1.0; 1.0 - Turkmenistan: 0.0; 0.8; 0.8 - Nigeria: 0.0; 0.6; 0.6 - Sudan: 0.0; 0.6; 0.6 - Mexico: 0.0; 0.6; 0.6 - Korea, Republic of: 0.5; 0.0; 0.5 - Guyana: 0.5; 0.0; 0.5 - Decrease in fiscal cost > 0.5 pct of GDP: - Barbados: 0.0; -0.7; -0.7 - Angola: 0.0; -1.1; -1.1 - Jordan: 0.0; -1.9; -1.9 - Note: The reported fiscal cost estimates in the survey are estimated using different methods and data than the more comprehensive subsidy estimates elsewhere in the analysis. ### Net subsidies by income level and net export status, end-2007 (summary from Table 6) - Table 6 reports net subsidies (benchmark prices inclusive of US$0.50 per liter tax) by gasoline, diesel, and total, with columns for weighted average net subsidy rate, net subsidy as percent of GDP, total net subsidy share. Selected entries (format preserved): - High income OECD: Gasoline 8.3 0.18 32.6; Diesel -5.3 -0.13 -18.5; Total 0.05 4.0 - High income non-OECD: Gasoline 48.4 1.16 64.0; Diesel 36.1 1.10 3.0 2.27 73.4 - Upper middle income: Gasoline 15.8 0.46 12.7; Diesel 25.7 0.89 19.5 1.35 16.5 - Lower middle income: Gasoline 44.7 1.53 46.5; Diesel 55.1 3.77 90.2 5.30 71.0 - Low income: Gasoline 38.7 1.67 4.2; Diesel 23.2 2.90 5.8 4.57 75.1 - Importer: Gasoline 13.5 0.32 67.4; Diesel 12.6 0.38 62.4 0.70 64.6 - Exporter: Gasoline 33.2 0.88 32.6; Diesel 38.5 1.28 37.6 2.16 35.4 - Total: Gasoline 16.7 0.41 100.0; Diesel 17.2 0.52 100.0 0.93 100.0 - Source: Staff estimates based on OECD and IEA data and data provided by country authorities. ### Coal: concentration, use, and subsidy evidence - Production and consumption concentration (Table 9, percent): - Largest producers: China 41.1; United States 18.7; Australia 6.9; India 5.8; South Africa 4.8; Total 77.3. - Largest consumers: China 41.3; United States 18.1; India 6.5; Japan 3.9; South Africa 3.1; Total 72.9. - Source: British Petroleum (2008). - Usage breakdown: - Over 80 percent of coal is used either in industry or for the generation of electricity and heat. - Electricity generation accounted for one-third of coal usage; 7 percent was used in combined electricity and central heating; central heating plants use slightly over 2 percent. - Industrial uses accounted for more than 38 percent; less than 3 percent was sold to final users. - Evidence on subsidies: - Consumer subsidies: mid-1990s consumer coal subsidies prevalent in transition economies of Eastern Europe and large Asian consumers. China has eliminated price subsidies on coal, but electricity prices remained regulated and apparently have not increased commensurately with coal price increases. India still has significant coal subsidies; quality-adjusted prices are low relative to international prices and such subsidies are not in the budget. - Producer subsidies: As of mid-1990s, Western Europe production costs per ton were two to three times import prices; differences maintained by import restrictions, direct budget subsidies, and minimum purchase obligations on utilities. Producer subsidies persist, especially in Germany, Spain, Poland, and Japan, though levels have been reduced. ### Natural gas: concentration and subsidy observations - Production and consumption concentration (Table 10, percent): - Largest producers: Russia 20.6; United States 18.8; Canada 6.2; Iran 3.8; Norway 3.0; Total 52.5. - Largest consumers: United States 22.6; Russia 15.0; Iran 3.8; Canada 3.2; United Kingdom 3.1; Total 47.7. - Source: British Petroleum (2008). - Observations: - Natural gas markets in the OECD and the EU appear relatively free of distortion. - The United States-Canada-Mexico market is largely self-contained, accounting for more than one-quarter of both production and consumption. - The EU is creating a single free natural gas market; new-member states have made significant progress in reducing energy and natural gas subsidies, often to expand gas grids to reach more customers. - Subsidies persist in some former Soviet Union countries; the IEA identified significant energy subsidies including natural gas in these countries. ### Food subsidies: price surge, trade patterns, and fiscal impacts - Recent price dynamics: - Prices of cereals and vegetable oils increased at an annual rate of about 50 percent between end-2006 and May 2008, with much of the increase occurring since the beginning of 2008. - Price increase for food exports measured in euros is slightly more than half the increase measured in U.S. dollars. - Cereals and oils account for less than half of food exports and are a much smaller share of food consumption. - Trade concentration (Table 11): - Number of exporters (2002-04) across products: All exporters 36 (corn), 30 (wheat), 29 (rice), 18 (soy), 58 (food). - Number of importers: All importers 154 (corn), 160 (wheat), 161 (rice), 172 (soy), 132 (food). - Trade share of top 5 exporters ranges from 93 to 100 across cereals; trade share of top 5 importers ranges from 22 to 51. - Short-term GDP impact of cereal price doubling: - Median impact: -0.9 percent of GDP for net importers and 0.5 percent for net exporters. - One-quarter of cereal importers have a loss exceeding 1.4 percent of GDP; five have a loss greater than 5 percent of GDP. Of these 25 importers, 15 are in Africa. - One-quarter of exporters have a gain exceeding 1.3 percent of GDP; three have a gain greater than 3 percent. All such exporters are in Latin America. - Policy responses observed (IMF survey 2008a): - Food taxes were reduced in 84 countries between 2006 and 2008; most reductions were in import duties (76 countries) rather than VAT (22 countries). - Twenty-two countries increased food subsidies (targeted and universal); six countries reduced subsidies. - At least 30 countries imposed export restrictions or bans on agricultural commodities, especially rice. - Table 12 reports patterns of food tax decreases by tax and country characteristics (counts by year and tax category); All Countries: 159; Import reductions reported in 76 countries; VAT reductions in 22 countries; Sales reductions in 31; Excise reductions in 49; reductions concentrated in 2008 for many low and middle-income countries. - Fiscal cost of food policy responses: - Cost of tax and tariff reductions ranged up to 1.1 percent of GDP in the 31 countries reducing taxes; fiscal cost was over 0.5 percent of GDP in eight countries. - Reduction in import taxes generated efficiency gains in some cases (Madagascar) but limited gains in others (Senegal) depending on import share of domestic consumption. - Subsidy increases were more costly: 22 countries incurred fiscal costs by increasing food subsidies in 2007 or 2008. - Fiscal cost exceeded 1 percent of GDP in 6 countries and 0.5 percent in another 5 countries. - In 2008 projections: total food subsidies are projected to exceed 2 percent of GDP in three countries, 1 percent in another three countries, and 0.5 percent in another 11 countries. - Table 13 lists countries with subsidies greater than 0.5 percent of GDP, 2008 (In percent of GDP): - Maldives: Increase (2007 to 2008) 2.9; Total subsidies (2008) 3.6 - Burundi: 0.6; 2.5 - Timor-Leste: 1.5; 2.3 - Egypt: 0.3; 1.8 - Jordan: -0.1; 1.7 - Morocco: 0.2; 1.2 - Indonesia: 0.1; 0.9 - India: 0.1; 0.7 - Turkmenistan: -0.1; 0.6 - Senegal: 0.5; 0.5 - Costa Rica: 0.5; 0.5 - Distributional and poverty impacts: - Average household food budget share: around 40 percent in middle-income countries and around 65 percent in low-income countries. - Food budget shares are substantially higher for lower income groups; burden of food price increases is highly regressive. - Empirical estimates: - Adenauer (2008): a doubling of rice prices in Senegal would result in a 12 percent decrease in real incomes for the poorest income quintile versus 5 percent for the richest quintile. - Coady, Dorosh, and Minten (2008): doubling of rice prices in Madagascar leads to a 25 percent income decrease for urban households in the bottom three deciles, about 10 percent for top decile; rural landless bottom three deciles decrease 35 percent; middle distribution over 15 percent; small rice producers and non-rice producers losses over 5 percent; big rice producers experienced welfare increase of 10 percent (bottom three deciles) to nearly 35 percent (top decile). - Ivanic and Martin (2008): first-order welfare effects from commodity price increases between 2005 and 2007 led to an estimated increase, ceteris paribus, of 4.5 percent in poverty rates (based on a poverty line set at US$1/day). *Source: Staff estimates based on OECD and IEA data and data provided by country authorities; IMF (2008a); British Petroleum (2008).* ### 42. But food subsidies are a fiscally costly approach to protecting the welfare of poor ### _090808a - 42. But food subsidies are a fiscally costly approach to protecting the welfare of poor ### Key findings on food subsidies and distributional incidence - Food subsidies are fiscally costly and a high proportion of benefits from low food prices accrues to higher income groups. - Senegal (Adenauer, 2008): around 64 percent of the subsidy for rice went to the top three income quintiles. - Madagascar: nearly 75 percent of the benefits of lower rice prices went to the top three deciles; subsidies essentially only transferred income from high income rural net rice producers to high income urban rice consumers. ### Issues and reform options — overarching recommendations - Key policy recommendations: - Pass through international prices to domestic prices to mitigate the impact on the balance of payments, promote efficiency, and contain negative externalities—although the price adjustment for some commodities may have to be gradual. - Rein in the fiscal costs of subsidies, especially when required by macro-fiscal considerations. - Protect the poor and other vulnerable groups from the impact of rising prices. ### A. The Importance of Pass-Through - Net importers can improve efficiency and mitigate adverse impacts of price increases by passing them through to domestic consumers; net exporters can achieve similar efficiency gains. - Example mechanism: for net importers with a linear import demand function, full pass-through will decrease the net impact of a doubling of import prices on the current account by a factor equal to 0.5 times the price elasticity of import demand compared to zero pass-through (see Appendix VI). - The mitigating impact will reflect consumption and production responses; import elasticity likely increases over the long run as producers and consumers adjust. - Estimated mitigating impact of full pass-through under conservative assumptions ranges from roughly 10 to over 100 percent (Table 14). - Table 14. Share of Price Impact Mitigated by Full Pass-through (Import share / Cons. & prod. elasticities) - Low / Low-0.28-0.15-0.09 - Medium / Medium-0.85-0.45-0.28 - High / High-1.42-0.75-0.47 - For exporters, the table gives the percentage of benefits foregone by not passing price increases through domestically; protecting domestic consumers via export restrictions or subsidies can be costly to exporting countries. ### B. Tax Policy Response - Tax policy should reflect revenue, efficiency, and equity objectives; changes in tax policy in response to price increases must be consistent with these objectives. - Issues of particular relevance: - Maintenance of revenue with ad valorem and specific taxes: - If demand for a fossil fuel is price sensitive, a price increase reduces demand and revenue from specific excises but may raise ad valorem tax revenue. If combined revenue increases and is not needed, cutting the excise tax level could contain the price increase. - Windfall taxes: - Calls for windfall taxes have arisen from profit increases due to higher oil prices. - Levying unanticipated taxes can damage credibility and discourage investment. - The best approach in principle is a permanent rent tax applying only to returns above a benchmark level; absent that, a temporary surcharge on corporate income tax for oil companies is simpler but may distort behavior. - Taxation of close substitutes: - Difficult to tax items disproportionately purchased by the poor at lower rates if close substitutes exist (e.g., different qualities of rice; diesel and kerosene), because higher-income households may capture the benefits. ### C. Subsidy Reform — obstacles and strategies - Obstacles to reform: - Weak capacity to target the poor. - Lack of transparency in reporting of subsidies. - Opposition by vested interests. - Spillover effects. - Ad hoc price setting mechanisms. - Targeting subsidies: - Compensating the poor for subsidy elimination requires resources and delivery systems; sophisticated safety nets may not be quickly feasible. - Gradual reform strategies while developing safety nets: - Temporarily maintain universal subsidies on commodities more important in poor households’ budgets (for instance, kerosene and lower quality cereals) because these are better targeted and more cost effective. - Identify a package of short-term measures to mitigate adverse impacts using existing programs that can be expanded quickly or improved in targeting (examples: school meals; reductions in education and health user fees; subsidized mass urban transport; cash transfers to vulnerable groups; subsidies for consumption of water and electricity below a specified threshold). - Provide well-targeted subsidies to farmers (input subsidies, smallholder credit facilities, extension services, improved infrastructure) to bolster production and income support for low-income farmers. - Identify high priority public expenditures that benefit poor households to be financed from subsidy savings (examples: education and health expenditures; infrastructure such as roads and electrification schemes). - Improve targeting and design of safety nets over time using categorical targeting, geographical targeting, self-targeting work or schooling requirements, or subsidizing items disproportionately consumed by the poor. - Box 1. Lessons from Experiences with Price-Subsidy Reform: 1. The appropriate speed of reform should be determined case-by-case; rapid reform is preferable if protection mechanisms for the poor can be established quickly. 2. Compensation schemes should be temporary and replaced with more formal social policy instruments. 3. A perfect targeting mechanism does not exist; choices can be restricted by lack of data and weak governance. Self-targeting often remains the only feasible option. 4. Using income for targeting is often impracticable in developing countries; targeting by household characteristics can be relatively efficient. 5. A general subsidy limited to, or below, the amount consumed by the poor protects poor households and politically vocal groups while generating budgetary savings. 6. Political risks can be assessed by identifying winners and losers; risks can be reduced by public explanation of benefits and avoiding undue burden on a single group. - Country experience with mitigating measures (Box 2): - Gabon: resumed National Social Guarantee Fund cash payments; improved census of lower income households; increased assistance to single mothers; free limited electricity and water for eligible households; waived public school enrollment fees and provided free primary school textbooks; accelerated PRSP investments; expanded mass public transport (27 buses). - Ghana: eliminated fees for primary and junior-secondary school; extra funds for primary health care in poorest areas via the Community Health Compound Scheme; expanded mass urban transport investment and rural electrification. - Indonesia: unprecedented cash transfer program to 19 million poor families in 2005; similar cash transfer accompanied the fuel price increases in 2008; reallocated some subsidy savings to education, health and infrastructure; reduced kerosene subsidies while promoting LPG as an alternative. - Jordan: increased minimum wage and higher wage increases for low-paid government employees; one-time bonus to low-income government employees and pensioners; maintained electricity lifeline tariff at current low levels; cash transfers to other low-income households; plan to increase funding to the National Aid Fund and improve its design and implementation with World Bank assistance. - Over time, the most effective approach is to develop a well-targeted safety net that facilitates structural adjustment, indexes benefits to price changes, and links transfers to social objectives (for example, school attendance and primary health care). Adenauer (2008) concluded that obstacles to social safety nets in Senegal could be overcome with gradual roll-out and external technical and financial support. - Promoting transparency: - Subsidies are often difficult to measure; some do not appear in fiscal accounts at all. - Subsidies should be recorded transparently in government accounts; off-budget subsidies should be identified and recorded in separate accounts; budget classification systems may need improvement. - For fuel subsidies, arrangements where oil companies provide subsidies without explicit budget support should be clearly defined in budget documents. - Transparency is especially important for oil exporters because the opportunity cost of fuel subsidies is the revenue foregone by not charging international prices domestically. Countries recording fuel subsidies explicitly include Indonesia, Iran, Malaysia, Sudan, and Yemen; Ecuador planned to include such fuel subsidies in the 2009 budget. - Some countries publish specific subsidy reporting systems (examples: Germany Biannual Subsidy Reports; Switzerland subsidy database on the web). - Overcoming vested interests: - Public information campaigns can mobilize support and overcome vested interests; organized beneficiary groups may resist reform while diffuse beneficiaries may not support reform without information or trust. - Example: Ghana used Poverty and Social Impact Analysis findings to build public support for petroleum price increases through extensive parliamentary discussions broadcast on state television and radio. - Assuring the public that savings will be used well and embedding subsidy reform within a broader reform package can help (example: Indonesia linked fuel price savings to a cash compensation program for the poor in 2005 and during the 29 percent domestic fuel price increase in 2008). - Addressing spillover effects: - Cross-border spillovers occur via altered trade patterns, smuggling, diversion of benefits, and environmental consequences. - Subsidized prices can incentivize smuggling and black market activity (examples cited: Nigeria and Venezuela for petroleum products). - Subsidies for intermediate inputs may pass through to exported goods’ prices. - Subsidized energy consumption can increase pollution, resource depletion, and global warming. - Rising biofuels production in advanced economies—partly in response to higher prices and policy support—has added to food price pressures. - Environmental spillovers include impacts on greenhouse gas (GHG) emissions: - Fossil fuels represent about two-thirds of current emission of GHGs. - Agriculture accounts for about 13 percent of such emissions. - Addressing these spillovers requires pricing (mitigation) and adaptation through changes in private behavior and public policies. Removal of subsidies and establishment of GHG emission pricing could have substantial positive impact on future temperatures, but measures have substantial distributional implications both within and across countries. *Italicized source: _090808a - 42. But food subsidies are a fiscally costly approach to protecting the welfare of poor* ### 59. Lack of pass-through of international prices to domestic prices and export ### 59. Lack of pass-through of international prices to domestic prices and export ### Effects on global demand and recommended trade stance - Lack of pass-through of international prices to domestic prices and export restrictions can have effects on global demand—a key spillover effect. - These policies provide perverse incentives and exacerbate the problem by increasing world prices further. - Recommendation: To avoid these negative international spillovers, commodity prices should be passed through to consumers and producers, and countries should refrain from imposing export restrictions. ### Multilateral cooperation on subsidy spillovers - Addressing the spillover effects of subsidies will require multilateral cooperation. - When externalities are global (for example, climate change), benefits of (potentially costly) unilateral action are limited: - If other countries do not take similar action, the gains are ephemeral. - If other countries do act, it can be in a country’s perceived interest not to join in (the free-rider problem). - Recommendation: International coordination of subsidy policies—perhaps with enforcement mechanisms—could usefully be discussed in the context of regional and multilateral surveillance. - Due to the distortionary impact of agricultural subsidies, the Fund continues to urge all countries to come to a prompt and ambitious conclusion to the Doha Round. - Footnote: FAO (2004) estimates that cotton subsidies in middle- and high-income countries amounted to US$3.4 billion during the 2003/04 season. Estimates of the impact on the world price range from 2 to 72 percent. ### Reforming price setting mechanisms - Government direct control of domestic prices has often been an obstacle to subsidy reform: - Prices of sensitive commodities such as fuel or bread are administratively set in some countries. - Even if prices are initially set or adjusted to reduce or eliminate subsidies, subsidies can reemerge or increase again if prices are not adjusted to reflect market conditions. - Political economy: once the government is seen as willing to cushion price increases, there will be pressures to pass on price declines, but not to pass on price increases. - Reform of the pricing mechanism is essential in reforming subsidies: - First-best solution: liberalize prices in the context of supporting institutional arrangements as needed. - Liberalization helps depoliticize product prices. - Evidence cited: liberalized regimes tend to be more politically robust than automatic pricing formulas (Baig and others, 2007). - Practical constraints: concessions (e.g., refineries under concession conventions), public-sector dominance of fuel import and distribution, need to strengthen regulatory frameworks and capacity to detect and discourage anti-competitive behavior. - If markets are imperfect or governments are concerned about excessive price volatility, implement automatic pricing mechanisms that adjust prices periodically in light of changes in international prices: - Price formulas designed to smooth pass-through of international prices to domestic prices. - Smoothing mechanisms listed: moving averages, price adjustment caps and/or triggers, and price bands (see Bingham, Daniel, and Federico, 2003). - Countries that at various times implemented formula-based mechanisms (in some cases temporarily) include: Bolivia, Chile, Republic of Congo, Dominica, Ghana, Gabon, Pakistan, Peru, South Africa, and Sri Lanka. - Note: such price formulas have often been suspended or abandoned in the face of opposition to price adjustments. - Challenge: develop pricing mechanisms sufficiently resilient to protect fiscal gains from subsidy reform; factors that promote subsidy reform more generally also promote resilience of pricing mechanisms. ### Collaboration between the Fund and the World Bank - The Fund and the World Bank can collaborate in responding to challenges posed by fuel and food shocks and in reforming subsidies: - The Fund can help governments assess mitigating measures, their cost, and fiscal policy options to accommodate policy response costs without prejudice to sustainability of financial positions. - The Fund can provide advice and technical assistance on assessing macroeconomic and fiscal consequences of subsidies. - The World Bank can assist in the design of subsidy reform, including establishment or strengthening of safety nets (such as school feeding, food for work, and conditional cash transfers); better understanding of the impact of biofuels; and action on the trade front to reduce distorting subsidies and trade barriers. - Fund and Bank staffs are working with OECD staff to establish coherence in policy advice on appropriate responses to fuel and food price increases. ### Conceptual framework for the measurement of subsidies - Definition: A subsidy is a form of government intervention resulting in a deviation of an actual price facing consumers and producers from a specified “optimal” benchmark price. - Benchmark under complete, perfectly competitive markets: marginal supply cost. - Consumer subsidy: consumers pay a price lower than marginal cost. - Producer subsidy: producers receive a price higher than marginal cost. - Consequence: departures from marginal-cost pricing generate inefficiencies (“deadweight losses”) and fiscal costs financed through higher taxes or lower public expenditures. - Deviations that justify adjustments to benchmark prices: - Externalities: corrective (Pigouvian) taxes and subsidies align private and social incentives; benchmark should include Pigouvian correction when relevant. - Imperfect competition: natural monopoly may justify subsidizing producers to allow marginal-cost pricing; benchmark price is marginal cost price. - When lump-sum taxes are not feasible and government must finance operations via indirect taxes: benchmark prices should include these optimal taxes; shortfall of actual from optimal taxes is a “tax subsidy.” - Distributional objectives when lump-sum transfers are not possible: optimal commodity taxes and benchmark prices should be adjusted to reflect distributional impacts (necessities vs. luxuries), acknowledging efficiency-distribution trade-offs. - Interaction of multiple deviations makes specification and measurement of benchmark prices more problematic. - Note: cross-country comparisons of tax subsidies must account for variation in optimal taxes across countries (footnote referencing differences in government size and financing method). ### Externalities in fossil fuel and food markets: implications for policy - Nature of externalities: - Short-term, localized effects: health risks due to air pollution; reduced water quality due to fertilizer use. - Long-term effects: soil salinization due to irrigation. - Global effects: global warming. - Environmental spillovers from fossil fuel combustion: - Coal and diesel: adverse health effects due to high emissions of sulfur dioxide and particulates. - Domestic stoves for heating and cooking: high exposure to pollutants, implying high health costs. - Emissions of greenhouse gases (GHGs): impose external costs on the global economy and future generations via long-term climate degradation and increased damages from extreme weather events. - Other spillovers: congestion and accident risk from transport. - Environmental spillovers from agriculture: - Conversion of pasture and forested land → biodiversity losses. - Water storage and irrigation → excess withdrawal of ground-water and increased salinity of aquifers. - Agriculture accounts for approximately 13 percent of total GHG emissions—primarily from energy inputs to fertilizer, by-products of livestock rearing, and impact on deforestation (which contributes approximately a further 18–20 percent of total emissions). - Biofuel production spillovers: - Recent increase in corn prices, likely at least partially related to diversion of corn to ethanol production in the United States, has raised the cost of producing meat and poultry and exacerbated tight supply in soybean and wheat markets. - Biofuels production may cause agricultural expansion into forested areas with habitat destruction and biodiversity losses. - Environmental effects include increased carbon emissions and negative impacts on air, water, and soil quality. - Some forms of biofuel production (particularly from waste by-products) may reduce GHG emissions considerably, while others—such as bioethanol production from corn and beet—are more likely to increase them. - Managing externalities is difficult and uncertain: - Requires understanding nature, extent, distribution of economic and welfare effects; intertemporal aspects are critical for long-lived externalities. - Aggregation over time requires choice of a discount rate. - Interactions among markets complicate policy (e.g., biofuel subsidies designed to reduce GHGs may divert agricultural production and affect food prices). - Policy approach to pollution emissions externalities: - Two-pronged: (1) mitigate via externality pricing (taxation, cap-and-trade, or hybrids) and technological changes; (2) adapt via changes in private behavior and public policies (reduce information barriers, tailor public services, foster insurance and credit markets). - Difficulties: estimating appropriate externality prices; shortage of quantitative evidence on likely costs and benefits of adaptation. - Distributional and international dimensions: - Externality pricing has substantial distributional implications within and across countries. - Effect depends on incidence: borne by final consumers (through increased prices) or fuel suppliers (including owners of fossil fuels), market structure, and regulation. - Example regressivity: gasoline price effects may be regressive where car ownership is high; kerosene effects more regressive where used for household lighting and heating. - Fuel taxation can redistribute scarcity rents among countries (e.g., petroleum importers vs. exporters). - Effective response requires international cooperation when vulnerabilities extend across borders (e.g., GHG emissions, shared water resources). - Policies need to deliver efficient mitigation and adaptation while ensuring distribution of benefits and costs are perceived as fair. ### Appendix III: Fuel price pass-through and international price evolution (end-2003 to mid-2008) - The appendix describes methodologies to calculate extent of pass-through and degree of fuel price taxation or subsidization. - Summary statement: Nominal international prices in U.S. dollars of gasoline, diesel and kerosene increased by between 222 percent and 274 percent from end-2003 to mid-2008. - Pattern noted: After an initial price increase up to end-2005, prices changed little in 2006 but increased more rapidly since end-2006. Over 60 percent of the increase in prices up to mid-2008 occurred since end-2006. - Appendix Table 1 — Nominal International Prices of Petroleum Products Since end-2003 (values presented as in source) - Product / 2004 / 2005 / 2006 / 2007 / 2008 - Percentage increase (cumulative) - Gasoline 21.7 74.9 86.8 168.5 222.2 - Diesel 39.8 92.5 108.2 189 274.1 - Kerosene 35.9 85.5 103.9 184.9 268.8 - Share of total increase (percent) - Gasoline 9.8 23.9 5.4 36.8 24.2 - Diesel 14.5 19.2 5.7 29.5 31.0 - Kerosene 13.4 18.5 6.8 30.1 31.2 - Source for table: Staff estimates based on OECD and IEA data. *Source: _090808a - 59. Lack of pass-through of international prices to domestic prices and export* ### 75. The calculation of fuel price pass-through is intended to capture how countries ### _090808a - 75. The calculation of fuel price pass-through is intended to capture how countries ### Fuel price pass-through: definition and measurement - Price pass-through (P) was calculated as the absolute change in domestic consumer prices divided by the absolute change in international prices, with all prices denominated in local currencies: P = (|q110 − q10|) / (|p110 e110 − p10 e10|) where q_t is the domestic consumer price in period t in local currency units, p_t is the international price in period t at the nearest world hub in U.S. dollars, e_t is the exchange rate in local currency in period t per U.S. dollar, and all prices are nominal. - For a given change in U.S. dollar prices, pass-through reflects: - Movements in the domestic currency–dollar exchange rate. - Changes in domestic fuel taxes and consumer prices. - Tax regime effects on pass-through: - If the exchange rate does not change and tax is fixed ad valorem, pass-through to tax-inclusive prices can be more than 100 percent (tax-inclusive pass-through higher than tax-exclusive pass-through). - Fixed specific tax levels result in pass-through of exactly 100 percent. - With both ad valorem and specific taxes, the recommended tax response when prices rise is: increase the absolute (specific equivalent) tax per liter and decrease the percentage (ad valorem equivalent) tax per liter; where both tax types are levied this will automatically lead to more than 100 percent pass-through to tax-inclusive prices. ### Interpretation issues and sensitivity - Pass-through estimates are sensitive to choice of start and end dates, particularly where prices are not market-set or automatically adjusted. - High measured pass-through can reflect both: - Passing through new international price changes; and - Reducing the size of initial subsidies (domestic price increases to eliminate subsidies). - Therefore, high pass-through in periods with little international price change but large domestic price increases may reflect subsidy removal rather than pure pass-through of new international price changes. - There is not a one-for-one correspondence between pass-through levels and absolute consumer price levels across countries for any given time period. ### Empirical patterns (median country, end-2003 to end-2007) - General summary: median country fully passed through international price increases in gasoline and diesel by end-2006, but not since then; pass-through decreased in 2007 due to rapid international price increases that were not passed through. - Appendix Table 2. Median Pass-through in Fuel Prices from end-2003 to end-2007 (Percent) - Gasoline: 2004: 18; 2005: 21; 2006: 14; 2007: 13; 10 - Diesel: 2004: 8; 2005: 8; 2006: 9; 2007: 5; 8 - Kerosene: 2004: 8; 2005: 2; 2006: 9; 2007: 2; 6 - Note: Based on data from 90 countries for gasoline, 88 for diesel, and 64 for kerosene. - Source: Staff estimates based on OECD and IEA data and data provided by the authorities. ### Consumer subsidies: measurement and benchmark - Consumer subsidies may not appear explicitly in government accounts when state-owned enterprises import/distribute fuels and are not consolidated with the budget; subsidy effects can appear as lower tax revenues or lower (higher) profits (losses) of state-owned enterprises. - Subsidy calculation requires: - Choice of an appropriate benchmark price. - Information on domestic consumer prices and fuel consumption. - Benchmark used in the paper: - International U.S. dollar price for the relevant fuel at the nearest international hub. - Adjusted by US$0.07 per liter to allow for shipping from the hub to the country. - Plus US$0.07 per liter to cover distribution and retailing costs within the country (domestic distribution and retailing costs based on per liter costs in the United States, Energy Information Administration (EIA), 2008). - For importers: benchmark = U.S. dollar price + US$0.14 per liter. - For exporters: benchmark = U.S. dollar price (margins cancel out). - Fuel consumption levels are based on OECD and IEA data. - Sensitivity and robustness: - Subsidy estimates are sensitive to benchmark choice and distribution margins; these vary by country and can be generous in some pricing formulas. - An increase in transportation costs of US$0.01 per liter would decrease estimated taxes or increase estimated subsidies by US$0.01 per liter in importing countries, and by US$0.02 per liter in exporting countries. - Small subsidy/tax differentials could cause classification shifts (e.g., a country with small price subsidies could appear to have low taxes, or vice versa). - The benchmark implicitly assumes zero fuel taxes as optimal; therefore subsidy estimates are underestimates to the extent that positive fuel taxation is desirable. Consequently, the paper also calculates subsidies based on a US$0.50 fuel tax level. ### Net tax rates: variation across products and groups - Median net tax rates at end-2007: - Gasoline: 57 percent of the before-tax price. - Diesel: 22 percent of the before-tax price. - Kerosene: -7 percent of the before-tax price. - Patterns: - Oil exporters have high subsidy rates, especially for diesel and kerosene. - Tax rates are especially high in high-income OECD countries. - Countries with automatic pricing formulae and with liberalized pricing have substantially higher tax rates than countries with ad hoc price adjustments. - Evidence suggests median ad valorem net tax rates have decreased while median equivalent specific tax levels have increased. - Appendix Table 3. Median Fuel Tax Rates by Group, end-2007 (Percent) — selected entries preserved exactly as in source: - Income Group - High-income OECD: Gasoline 157, Diesel 103, Kerosene -17 - High-income non_OECD: Gasoline 74, Diesel 1, Kerosene -82 - Upper middle-income: Gasoline 41, Diesel 21, Kerosene -16 - Lower middle-income: Gasoline 23, Diesel -1, Kerosene -24 - Low income: Gasoline 63, Diesel 29, Kerosene 11 - Region - AFR: Gasoline 82, Diesel 42, Kerosene 3 - APD: Gasoline 44, Diesel 11, Kerosene -10 - EUR: Gasoline 151, Diesel 103, Kerosene 90 - MCD: Gasoline -10, Diesel -44, Kerosene -51 - WHD: Gasoline 30, Diesel 8, Kerosene -17 - Oil Trade - Importer: Gasoline 72, Diesel 31, Kerosene 5 - Exporter: Gasoline 1, Diesel -34, Kerosene -51 - Pricing Regime - Ad Hoc: Gasoline 14, Diesel -25, Kerosene -33 - Formula: Gasoline 75, Diesel 37, Kerosene 14 - Liberalized: Gasoline 41, Diesel 18, Kerosene 19 - All: Gasoline 57, Diesel 22, Kerosene -7 - Number of countries: Gasoline 126, Diesel 124, Kerosene 71 - Note: Tax rates defined as the difference between domestic retail prices and benchmark prices divided by benchmark prices. - Source: Staff estimates based on OECD and IEA data and data provided by country authorities. ### Regional and policy observations: Europe and transition economies - EU countries: - Most EU countries have reduced or eliminated energy subsidies over the past two decades; pricing is at economic levels and policy focuses on grants, taxes, regulatory instruments, R&D, internalizing environmental externalities, and developing renewable/alternative technologies. - Common objectives for EU energy subsidies: protect domestic energy industries; pursue industrial policy (technology lead); address environmental concerns; equity objectives (social welfare and targeted measures). - Common subsidy forms: grants and credit instruments (e.g., Denmark subsidizes up to 30 percent of investments in energy efficiency), fiscal instruments (differential taxation, carbon taxes, Ecological Tax Reform), regulatory instruments (e.g., subsidized tariffs for wind-generated electricity in Germany), and public funding of R&D (energy R&D for European IEA members increased by about 20 percent in real terms between 2000 and 2006; about 40 percent of spending goes to nuclear energy, 15 percent to fossil fuels). - Magnitude examples: Reduced VAT rates for oil and gas consumers in the United Kingdom estimated to cost around €1.4 billion; state aid for the coal sector in EU-27 countries between 2002 and 2006 amounted to about €31 billion; Denmark reduced rates implied an off-budget subsidy of about €0.6 billion. - New EU members (EU-10): - Energy subsidies were drastically reduced during pre-accession; in some countries (Bulgaria, Hungary, Romania, Slovakia) declines exceeded 60 percent, though some substitution between electricity and gas subsidies occurred; Latvia and Poland saw increases; trend toward subsidies (with EU co-financing) to promote energy efficiency and renewables. - European non-EU and transition economies: - This region includes some of the largest energy subsidies globally, often due to unfinished reforms and weak regulatory frameworks, particularly for natural gas and electricity. - 2006 IEA World Energy Outlook estimated Russia had about US$40 billion per year in energy subsidies in 2005 (mostly natural gas and electricity). - Several countries have tariffs below cost-recovery (Azerbaijan, Kyrgyz Republic, Tajikistan, Uzbekistan); some countries sold gas below import costs (Azerbaijan, Serbia). - Balkan subsidies concentrated in electricity; progress toward cost recovery has been uneven; cross-subsidies from businesses to households remain significant; planned reforms in some countries (e.g., Croatia aiming for cost-reflective tariffs by 2010; Montenegro planning to eliminate cross-subsidies in medium term). ### Biofuels: opportunities and challenges - Opportunities: - Environmental: potential to reduce greenhouse gas emissions; currently only 1 percent of global transport energy comes from biofuels; some countries (including in the EU) aim to increase biofuel share in transport to about 5 percent of total energy consumption by 2015. - Energy independence: increase renewable share to improve energy security. - Rural development: expansion of biomass production could offer agriculture diversification and job creation, though economies of scale may limit benefits to small-scale farmers. - Challenges with first-generation biofuels (made from sugar, starch, vegetable oil, or animal fats): - Low effectiveness: life-cycle emissions from first-generation biofuels frequently exceed those of traditional fossil fuels once production and transport are included; forests on the same land could absorb up to nine times more CO2 than first-generation biofuels could save. - Cost efficiency: not cost competitive with fossil fuels at current factor prices; governments support biofuels via consumption incentives (fuel tax reductions), production incentives (tax incentives, loan guarantees, direct subsidies), and mandatory consumption; total support by OECD countries estimated at US$11 billion in 2006, with the United States and the EU providing close to US$5 and US$6 billion respectively (Steenblik, 2007). - Competition with food: diversion of feedstock to biofuels reduces food supply; United States reportedly used 20 percent of its 2006/07 maize crop to produce ethanol; IEA (2004) reported 43 percent of cropland would be needed for biofuel production if U.S. and EU plans proceeded; Rosegrant (2008) estimated biomass diversion to biofuels accounted for 30 percent of the recent increase in weighted average grain prices. *Source: IMF staff estimates and analysis as presented in the supplied PDF content.* ### 91. Outlook. Second-generation biofuels—made from a wider range of biomass, such as ### _090808a - 91. Outlook. Second-generation biofuels—made from a wider range of biomass, such as ### Second-generation biofuels: outlook and potential - Second-generation biofuels—made from a wider range of biomass, such as straw, grasses, and wood (lignocellulosic material) and using advanced (and currently noncommercial) conversion technologies—could reduce production costs and achieve significantly higher reductions in greenhouse gas emission. - Biofuel producing countries—including Germany, the United Kingdom, and the United States—are working toward commercially viable second-generation technologies to make biofuel a more viable energy resource. ### Appendix VI — Mitigating the impact of price increases: pass-through vs. subsidization - The most efficient response to increasing world prices for energy and food is to fully pass through these price increases to domestic consumers. Full pass-through provides the appropriate incentives for producers and consumers to increase production and decrease consumption. - Analytical illustration setup: - Initial world price: p - Change in price: bepΔ - Initial net imports: M - Change in net imports due to the price change: MΔ (MΔ<0 for a price increase) - Welfare impacts under two pass-through scenarios: - Full pass-through (FP), assuming linear import demand: - Aggregate loss in welfare experienced by consumers and producers (FP) is given by ).0.5(.pMpMΔ+ΔΔ, where MΔ<0 for a price increase. - In the absence of any existing taxes and subsidies, the fiscal impact of full pass-through is zero. - Zero pass-through (ZP): - Domestic prices do not change so that the aggregate welfare impact on domestic consumers and producers is zero. - Government subsidizes the domestic price; fiscal cost equivalent to .pMΔ, which is also the aggregate impact on the country (ZP). - Comparative mitigation share formula as presented: - .0.5(.) 110.50.5 . . ZP FPFPp Mp MM ZPZPp MM −Δ+ΔΔΔ =− =−=−=− ηρ Δ - where is the price elasticity of net import demand and 0η<ρ is the proportional increase in world price. - Price elasticity of net imports: - CY - CY - MM - η=η −η - where C is total consumption of the good, Y is total production and ,CY η denote the price elasticities of consumption and production respectively. ### Import elasticities: values and implications (Appendix Table 4) - For simulated values (consumption and production elasticities of -0.1, -0.3, and -0.5; import shares of 30, 50, and 70 percent), the import price elasticities will range from -0.2 to almost -3. - The share of the impact of a price surge that will be offset by full pass-through is one-half of the import price elasticity. - Appendix Table 4. Import Elasticities (table entries preserved): - Import share / C & Y elasticities - Low: -0.57 -0.30 -0.19 - Medium: -1.70 -0.90 -0.56 - High: -2.83 -1.50 -0.93 ### Effects of existing taxes on welfare calculation - With existing taxes, welfare impacts of full pass-through must account for the change in existing tax revenues due to the change in net import demand. - For a price increase, this results in a decrease in import revenues (a welfare loss). - Net revenue impact should also account for indirect revenue impacts (for example, consumers switching to other taxed goods). If substitute goods are similarly taxed, indirect revenue effects will be small. ### Energy consumption — key aggregated statistic (Appendix Table 5) - TOTAL WORLD energy shares (final line preserved exactly): - TOTAL WORLD35.623.828.65.66.4100.0100.0100.0100.0100.0100.0100.0 *International Monetary Fund. Content unit: _090808a - 91. Outlook. Second-generation biofuels—made from a wider range of biomass, such as* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2008/_090808a.pdf_