Can we use energy subsidies to take from the rich and give to the poor?

Countries around the world tax and spend in many different ways. Some have more progressive tax systems, some invest more in infrastructure and public education, others have a small public sector. Almost as a rule, however, every country in the world subsidizes energy consumption. A report by the IMF shows that post-tax energy subsidies amounted to $5.3 trillion in 2015, or 6.5% of world GDP.

In many countries, prices for fossil fuels like gasoline or natural gas are directly regulated by the government. In many others, a “basic level” of electricity consumption is directly subsidized through the use of block pricing. Block pricing is when one price is paid for the first 1000 KWh of consumption in a month, but a higher price is paid for the next 2000 KWh, for example. In some countries, like Colombia, electricity prices are based on the average income in your neighborhood, with below cost prices in the poorest neighborhoods and above cost prices in the wealthiest neighborhoods.

There are many reasons we may be concerned by this type of policy. In particular, subsidizing energy has many adverse environmental impacts, from increased air pollution to greenhouse gas (GHG) emissions. Yet, not only are energy subsidies present in almost every country in the world, they are perhaps the most popular policy among constituents. Many people love their energy subsidies and are willing to fight to protect them.

In Mexico, the gasolinazo, a removal of government subsidies for gasoline by the administration of current president Enrique Peña Nieto, has lead to mass demonstrations, with over fifteen hundred arrests across the country this year. In Bolivia in 2011, a government attempt to reduce government subsidies was met with such public backlash that the subsidy reform was scrapped within 5 days.

These subsidies are often part of a populist policy package designed to attract low income voters. The rhetoric associated with energy subsidies often emphasizes energy access as a right, and suggests that energy subsidies effectively redistribute income from the rich to the poor. But is this really true?

First, we should note that energy expenditures make up a much larger share of income for the rich than for the poor. This is true virtually everywhere across the world, despite the fact that wealthy individuals consume vastly more energy. This empirical observation leads many to argue that energy subsidies are “progressive”, or that any type of energy tax would be “regressive”.

If we define regressive taxes as those that will make up a larger percentage of income for the poor than the rich, then taking away energy subsidies, and in fact most subsidies for any basic necessities, would be seen as regressive. However, this does not mean that either measure is particularly effective at taking money from the wealthy to the poor.

Suppose a country raises most of its tax revenue from individuals in the middle class and wants to create a subsidy for electricity consumption paid for with income tax revenue. We know that energy consumption is increasing with income. Then the individuals who would receive the largest direct transfers from the government would be high income individuals because of their large consumption. The individuals who would receive the smallest transfers would be the poorest individuals who would consume the least electricity. Energy subsidies are effectively transferring money from the average tax payer to the wealthiest people in society.

Of course, in many countries, only high income people really pay taxes. Even if it were the case that all of the tax revenue came from the top 10% of consumers, an electricity subsidy would be a very inefficient way of redistributing from the wealthy to the poor. It still remains the case that the smallest transfers are to the poor and that the rich get the largest absolute benefits. Even block pricing at best gives as much money in subsidies to the rich as it does to the poor.

A classic paper in public economics by Atkinson and Stiglitz (1976) shows that it may be preferable to use the income tax system to redistribute across society, that is tax the rich and give checks to the poor, rather than taxing and subsidizing different consumption goods. However, many countries have challenges implementing these types of schemes, for both political and practical reasons (unbanked populations, corruption). An alternative (and rarely discussed) option that Atkinson and Stiglitz propose is to tax things that only the wealthy would use and subsidize things that only the poor would use.

In many developing countries, this can be done through the provision of public services. Most rich people have their own cars, use private health facilities, and send their children to private schools and universities abroad. It is the poor and middle-class that are more likely to consume these goods. Subsidizing these activities with tax revenues would more effectively transfer income from the rich to the poor and middle-class. Some of these investments, like higher education, are more popular with the middle class so it may be preferable to focus on things that the poor consume exclusively like public education in very poor areas.

Atkinson and Stiglitz’s result highlights how misguided it is to redistribute through energy subsidies. Energy is exactly the type of good that you should not use for redistribution. Consumption is increasing with income. The rich have larger homes and televisions. They are more likely to own a car and drive it to work instead of taking a bus. They are more likely to travel on gas-guzzling airplanes for vacations.

We are not even taking into account the fact that the poor may be more vulnerable to the negative environmental impacts from energy consumption. They are certainly more vulnerable to heat from climate change in tropical countries, with limited access to air conditioning. They are also likely more vulnerable to air pollution due to the many more outdoor occupations that low income people engage in. Finally, they are substantially more likely to live near polluting electricity generation plants and oil refineries, precisely because homes near these plants are cheaper due to high air pollution.

An effective redistributive policy through taxes and subsidies would either try to get cash directly poor individuals or would subsidize specific goods that the poor are more likely to consume than the rich. If we are trying to redistribute from the rich to the poor, we certainly should not be making it cheaper for people to drive a Ferrari or go on vacation to Hawaii. Instead, we should make it cheaper for people to ride the bus, or improve the quality of low-income public schools, because we know rich people are not going to consume either of these goods.

A final note: Protests against energy subsidy cuts may not be misguided, but motivated by political failure. Subsidy cuts are often part of a package of policies meant to reduce government spending and budget deficits. The funds for these subsidies are not re-directed to other spending for the poor. Instead, subsidy reductions make it possible to reduce income tax rates, which are less relevant for the poor than the wealthy. Neither of the reforms above was accompanied by a new and improved redistributive policy, like a check in the mail for every low-income household or more spending on rural public schools and public infrastructure. Knowing this, the poor in Mexico and Bolivia may have (rightly) interpreted these policy changes as reductions to one of the few benefits they get from the government in exchange for a balanced budget or lower income taxes for the rich. When that is the flip-side of an energy subsidy cut, it seems rather unlikely that you will get any support from the poor.

 

Image courtesy of Flickr. Originally published by S&S on April 14, 2017.

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