22409 vie Vi pOlnt Incentive-Based Subsidies I'h'iAca tdse siiTtlview's Designing Output-Based Subsidies for Water Consumption (Chile " experTien(ce of utsing tlix-Junded subsid y paynents, (continigentt To guarantee adequate and affordable water and sanitation services for deliv}ers' of sen'ieeh 7la/er cOT/paIie;s. ivulnerable households, Chile introduced an individual means-tested water FondingthesAhbidv consurnption subsidy a decade ago. Although the public authorities throtigh gneieel-l taxati oii throughe gerog taxtto set determine how the subsidy is applied, the mostly private companies deliver ezilluus the lis gu lator to se t uriJJs according to the seirvice-under a scheme with built-in incentives to ensure cost-effective economic ctiieteia. service delivery by the companies and low wastage by the customers. Targetiug ollotioz)s carM re. ouzrte-s lo be i/ire/d lo In the late 1980s Chile began an overhaul of the geted to individual customers rather than a tra- thoese u;zh 0 lesd slub idi es tmoist Both lii Susiriteriscs legal, economic, and institutional structure of its ditional geograplhic or univer-sal subsidy. rinost. Both (hamalemlitie reduce thefi n an eial water and sanitation sector. An important part of The subsidy program, introduced in the the reform was a new tariff setting methodology earlv 1 990s, relies on the water companies to bnMenis on the onverntnenlt I , K/ c ro mpanred u'jtl the aimed at raising water prices to the trte economic deliver the service. The government reimburses aiersnar shssd utsed iTI cost of the service. Before the reform water tariffs them for the subsidies on the basis of the actual the pa.st. TI'he wr'ite-up/:) of covered less than 50 percent of this cost-and amount of water constimed by eacli beneficiary this eose studi' has been only20 percentin regioiiswliereproductioncosts rather than a preestablished amount, a method Junded by the Pulich- I were high. Steady tariff increases in the 1990s used in some countries. With the most impor- Private Jnfrastrurcture dotubled real charges for Empresa Metropolitana tant water companies having been privatized Adlvi.sor-T FoeTl ity, a de Obras Sanitarias (EMOS), the senice provider since 1998, private companiies now serve 73 per- odiiltidonor technical in the Santiago metropolitan area and the coun- cent of urbani clients. So the subsidy scheme is a75 Mistance Progr usn. try's largest water company. Rates increased even essentially being implemented by private com- more for the smaller companies, especially those panies on behalf of the government. operating in high-cost regions. As a result of these large rate hikes, a new How the subsidy works mechanism was required to protect vulnerable By law, the subsidy can cover 25-85 percent of a households. Since connection is almost universal household's water and sewerage bill for up to 20 in Chile's urban areas, the affordability of con- cubic meters a monith (though the limit IoIW sumption-not of connection-was the main used is 15 cubic meters a month), with the client issue, and a consumption subsidy wvas the obvious paying the rest. All consumiiption above the limit solutioni. Chile chose a means-tested subsidy tar- is charged at the full tariff. INCENTIVE-BASED SUBSIDIES DESIGNING OUTPUT-BASED SUBSIDIES FOR WATER CONSUMPTION _________________________________________________________ To obtain a subsidy, a household must apply to its municipality, which determines its eligi- An eligibility scoring system called CAS is the main tar- bility mainly on the basis of a scoring system geting instrument used in Chile for distributing means- called CAS (box 1) 2 Another important crite- tested subsidies. It produces a score for each household rion is that households mtist not have payment wishing to be evaluated based on a personal interview arrears with the service provider. at its dwelling. The questionnaire used includes 50 ques- The municipalitv must award subsidies in the tions on general information, identification of household order of the members, living conditions, crowding conditions, health applicants' CAS scores. Subsidies 2 conditions, comfort, occupation and income, ownership of are normally renewed yearly for tp to three years durable goods, and other socioeconomic variables. Once before a household must reapply. Butt if a munic- the interview is conducted and the (AS score calculated, ipality has distributed all the subsidies assigned the score is valid for two years, and the household can to it and a new applicant has a lower (AS score use it to apply for many different subsidies. Besides the than the last beneficiary, the municipality must water subsidy, eligibility for pension payments, family withdraw the benefit from this last beneficiary subsidy, free health benefits, and other subsidies is and assign it to the more deservinig applicant. determined on the basis of the (AS score. Many municipalities outsource the interviews to pri- Incentives vate survey companies, but still calculate the (AS score. The subsidy scheme has several incentive-based That lowers the risk of collusion between interviewers features. One centers on the fact that the and households, since interviewers do not know the exact relationship between the households' answers and I their CAS score. depends on the level of consumption, and results from two aspects of the program's design. First, the subsidy is expressed as a per- centage of the household's bill. It is therefore a Each year the Ministry of Planning price reduction per cubic meter consumed, and (Mideplan) determines, for each region, how no benefits are given if there is no consumption many subsidies are to be granted and how they or deliverY of service. Second, the household are to be applied, following several general prin- must pay the full tariff for consumptioni above ciples: The subsidy is based on the willingness to the limit of 15 cubic meters a month. pay for water services among low-income house- This consumption limit reconciles the need holds. Only households that would be unable to to provide income support to low-income house- purchase what is considered to be a subsistence holds for basic water consumption with the need level of consumption should benefit. And the to preserve financial incentives for efficient subsidy should cover only the shortfall between resource use. In essence, the Chilean water sub- actual charges and willingness to pay.' As a sidy can be thought of as a rising block tariff, crude proxy for willingness to pay, Mideplan where only means-tested households have access uses the benchmark set by the Pan-American to the lower priced initial consumption block.3 Health Organization-that no household The fact that the subsidy scheme requires should pay more than 5 percent of its monthly households to pay a fraction of the bill even income in water and sewerage charges. It is when their consumption does not exceed 15 unclear whether vulnerable households in cubic meters helps to maintain good payment Chile would be willing to pay more or less than habits among clients. It also preserves service this 5 percent. providers' incentive to improve commercial The subsidy scheme is funded entirely from efficiency, since their income depends in part the central government's budget. Using house- on the payment of this remaining charge. And hold survey information for each region and the additional eligibility requirement of not each company's published tariffs, Mideplan can having payment arrears has led to an improve- determine how many households need a sub- ment in clients' payment record. sidy and how large benefits need to be to meet Another incentive-based feature of the the benchmark for each region. scheme rests on the relationship between the government and the service provider. This rela- Financial control and procedures for the tionship is mediated by the subsidy law and its Figure subsidy scheme accompanyingregulations.4 The lawrequires the 1 companies to bill beneficiarv clients net of the Presents an invoice ter subsidy amount and then bill the municipality for to municjality c the subsidies granted. The municipality is thus a V client of the service provider, meaning that it can and sends it Municipality Pays water be charged interest for late payment and that the to governor c service can be discontinued as a result of non- Aggregates invoices 3 payment (so that in the next payment pe]riod the of all municipalities Regional Transfers funds and presents reginonal goeror o municipalities service provider can charge beneficiary house- invoice to Ministry holds the full amount of the bill). of the Interior This setup gives municipalities a strong Validates regional Ministry o incentive to transfer payments quickly to opera- invoices and presents the Interior consolidated invoice Undersecretariat tors. The central government funds for the pro- to Budget Office fnr Regional gram are earmarked, so municipalities do not evelnpment stand to benefit financially from withholding s eapenditure payment to the water companies. And the polit- of Finance and deposits funds ical wrath that could arise if they faile(1 to pay B Oregional trauysaccount the sernice providers-and thus lost the benefit for households-is potentially costly. The financial flows and control of the pro- perhaps through the redluction of payment gram are concentrated in the Undersecretariat arrears by poor households. for Regional Development of the Ministry of the Interior (figure 1). The process requires that Take-up the company and municipality have synchro- In 1998 nearly 450,000 subsidies were distributed nized lists of beneficiary households and that nationally, benefiting almost 13 percent of house- the interior ministry verify that the regional holds by an average US$10 a month. The total invoice is consistent with the number and value cost was US$33.6 million. In some regions where of subsidies for the region approved in the incomes are low and water charges high, close to annual budget. The arrangement is clearly a third of households received the subsidy. On bureaucratic, and municipalities are often average, 52 percent of benefits in each region unable to pay the companies' invoices on time. accrue to the three lowest income groups, and Some companies charge the municipalities only 23 percent leak to the five highest income interest for the payment delay. The municipali- groups (figure 2) .5 Subsidies represent a larger ties must bear the interest and debt costs result- share of income for poorer households, nearly 8 ing from late payment. since there is no percent for the lowest income group. provision in the national water subsidy budget for these charges. Lessons Despite this problem, the fact that companies The introduction of the subsidy-and especially receive a reimbursement for services and subsi- the targeting results achieved-have been key to dies already delivered has several benefits. The Chile's ability to raise water tariffs to levels reflect- arrangement gives the companies full incentives ing costs without compromising its social and for providing efficient and reliable service. The distributional goals. And the costs to the govern- subsidies accrue to households, not companies, ment of doing so have been low. The cost of the and the amount of resources distributed is inde- subsidy in 1998, US$33.6 million, was well below pendent of the service provider's operational the cost of the previous universal subsidy scheme. efficiency. Companies should be indifferent Before the reforms in 1988 the water and se-wer- with respect to the subsidy scheme and receive age sector had a financial deficit of 2 percent of no financial benefit from the program, except assets. But in 1998 this situation was reversed. INCENTIVE-BASED SUBSIDIES DESIGNING OUTPUT-BASED SUBSIDIES FOR WATER CONSUMPTION __- Chile, some mutnicipalities still lack sufficient capacity to adequatelv administer and cointr-ol the Share of total subsidy expenditure subsidy scheme. For couintries with less institu- * Share of total subsidy expenditure tionial capacitv suchi a complex system may not be * Average subsidy as a share of household income InCDme decile Percent 6vable. Thiese couintries couild adlopt siiyiplei- tar- vew o n Income decile Percent U ' f.xml,ashm ae VI W O1t 0 5 10 IS 20 getig meciainisiis, forexample,ascieilebased on a geograplhic povertv map, like that used in I _____________________________________________ Colombia. Moreover, a schemiie using a coIIIIec- 2_ tion rather tlhani a constmptioni subsidv will 3 require less instittutionial capacitwy, since hulse- enco urage dissemination of ________________________________________________ ~~~~~~~public policy innovations for 4_ holds' eligibility mulst be evaluated ofllY once. private sector-led and Third, an individuial means-tested subsidy 5 ' market-based solutions for ________________________________________________ may be expensive to apply. Chile uses the same development. The views 6 _ targeting instrurnent to distribute several wet- published are those of the fare benefits, lowering tdie adsinistiistiatve costs authors and should not be B significantly. Applying such a scheme for- only attributed to the World one subsidy program imiay be too expensive. Bank or any other affiliated Again, hlowever, the adminiistr-ative costs for a organizations. Nor do any of connection subsidy are much lower than those, the conclusions represent for a consutmption subsidv. official policy of the World Note: ln(ome deciles are based on per capita household inoose. Data include only households with shared or own water counections. Bank or of its Executive Source: Mideplan (Ministry of Planning), "Encuesta de taracterizacin Socooeconorica Nasonal" (Santiago, 1998). Directors or the countries they represent. Companies reported a surplus of close to 4 pe'- Notes cent of assets and net profits of US$107 million, I. This is nOt teo sav that iio lrthuir lnenfctits shotlu(i To order additional copies more thani three tinacs the cost of the stobsidy accrutc to low-jic(ine heoiusetiolds for purely distnibla- contact Suzanne Smith, schemiie (excludinig atlministrative costs). tioenal i'easiOis, eanlv Thtat the best way to inseet such goals managing editor, Despite the successes of the subsidy program, tusav he tairotigla general welTare pu-ogr-atuas, aiot c seStonual Room 19-017, several isstues need to be conisidere(i if' such a consiutiuptiont slubsidy. The World Bank, sclhemle is to be replicated in othel cotuntries. 2. C.,tS counaes liotis Connit6s de Asisteneci: Social 1818 H Streec, NW, First, meterinlg is a prerequtisite for this type of (lo:iennal (Coannitioanal Social Assistaiace (Coiaiuaittces), Washington, DC 20433. outpllt-based conistLtimptioni subsidy. For couin- which pieoitotc(t the idea oe easiiig a stai(lai-d ullecoSUt ce ie tries witli low coverage of' meters amonig low- allocatitig socialt esoturces aunsostg the poor. 005 202 458 7281 income hotusehiolds, suIch1 a sclheme may not be 3. A Cs1SUIllptioa a-hasedt sublsidhy ruequir'es that eacta Fax: viable. In these counltries, however, the most hotaseltold have a nneter. I'his is notl l otllch os all isslic ial 001 202 522 3181 pressing social issue usually is niot enstiring that Chile, whccle meterI tag is ahritost atniveie sae in tirlbana areas. Email: water is affordable, bhtt increasinig the number 4. 'Ithese lIWS atIt regtilaoionis ar-c availahbe in ssmith7@worldbankorg of connlectionis. For that ptirpose, a means- Spareisla at ws,s'.siss.cl. tested sttbsidv analogouis to the one in Chile 5. Bvconap.risoin,itiCtolosahiba,ttweaohlvothr( -altiio would be easier to apply, since metering is ImOt Amisericana cottitirvsitla aia iinaportanit fornnial water suobsidy Printed on recycled paper requtir-ed. Service providlers cotild charge new schetase, 37 pertcent ot stuhsidies Iracts thle five iiglhest clients the true cost tat' coninection-perhiaps iFceCtrle goorLpS. providing some credit by pernitting payment in installments-minuis a subsidy to eligible house- Anteeiis G6aez-Imoliz o Uvlgsataz&sts feee. as le tin. ifs, e)ti' ')e hiolds. The govermlletat could then reimburse aiy a](JChile. tht service providerss on tthe basis of the nuttmber .- of eligible hlouiselholds connected. INFRASTR CTU RE ADVISORY FAC teITY Secotid, the tmeans-tested targeting used in Chile requtires a certain am)ount of institutionial capacirt, especially at the municipal level. Even in This Note is available online: www.worldbank. o rg/html/fpd/notes/