33354 World Bank Social Safety Nets Primer Notes 2003 No. 4 Price and Tax Subsidies: Effectiveness and Challenges Many governments use price and tax subsidiza- price subsidies, exemptions under value-added or tion to meet social protection objectives. They other sales taxes, dual exchange rates, export endeavor to reduce the cost of living for their pop- taxes, producer quotas, subsidies on transport ulation--or for a subset of the population--by and storage, and domestic sales of a commodity subsidizing the price of goods or services in lieu below international opportunity cost. Subsidies of, or in addition to, direct income transfers. on goods available in a rationed amount are a less While these subsidies may distort production costly alternative to open ended subsidies on the incentives, subsidize the non-poor more than the entire supply of a good. poor, and limit consumer choice, there are reasons why a government may choose to use some forms Benefits and Effects of pricing policy rather than make income trans- Price subsidies are most commonly assessed in fers to help the poor: terms of their incidence--that is, who benefits from the subsidy. In general, who gets the subsidy · Subsidies can be used to promote socially desir- or who does not depends on a number of policy able policies, such as investment in education decisions regarding which commodities are cho- or healthy nutrition. sen, what type of targeting, if any, is used, and · Subsidies can be used to encourage at least a what marketing channels are employed. minimum level of consumption of certain goods--sometimes termed `merit' goods-- For many commodities, including most common- which are given extra weight in economic cal- ly consumed grains, wealthier households con- culations. sume more and thus receive larger transfers in · It is sometimes easier to obtain political sup- absolute terms, making the subsidies poorly tar- port for commodity subsidies than for direct geted. Nonetheless, the amount of transfer that a income transfers. poor household receives will be a larger share of its budget than for a non-poor household so that · Subsidies may be easier to administer than a reduction in subsidies will disproportionately income transfers. hurt the poor. Some goods--meat is an exam- · Subsidies may be more effective than transfers ple--are inappropriate vehicles for redistribution when commodity markets are under-devel- as subsidies on them will not only accrue mainly oped. For example, income support alone can- to the rich but will actually increase welfare not counter a famine if there is no network for inequality. food distribution. A few governments have been able to subsidize Forms of Subsidies goods for which consumption declines as incomes The most common form of price subsidy is a increase. These `self-targeted' subsidies avoid the direct, untargeted subsidy. However, various other problems of gathering information on each means may be used as well: untargeted indirect household to determine benefit eligibility, as with Fiona Mackintosh and Carlo del Ninno prepared this note based on Alderman, Harold. 2002. "Price and Tax Subsidization of Consumer Goods." Social Protection Discussion Paper No. 0224. World Bank. Washington, D.C. a means test, and yet can result in aid directed to ogy--in the form of cards suitable for scanning-- the poorest households. Even so, the poorest 40 can provide cost-effective monitoring mecha- per cent of the population receives only a half to nisms, though this solution may be problematic two-thirds of the benefits of the most successful in communities without sources of power for self-targeted subsidies, compared to more than scanning devices. four-fifths of the benefits of a means-tested trans- fer program. Finally, government intervention may have adverse consequences. For example, public-sector With many food subsidies, policymakers are con- transportation and storage of grain might be jus- cerned more with the impact on total nutrient tified by the lack of a private market able to han- consumption rather than with the level of the dle the volume of trade that is needed for a transfer. And there is substantial evidence that national subsidy program, but it may also limit subsidies on specific foods do affect nutrient con- the development of an efficient private market- sumption in a manner different than income ing sector. transfers. The reduced price will have a direct influence on purchases of commodities with gen- The Politics of Subsidies and Reforms eral subsidies and for rations that exceed the Few governments have introduced new general amount normally purchased. But even in the food price subsidies recently, and many have case of quotas and food stamps there is evidence reformed existing systems of subsidies. The poli- that the presence of food-related transfers tics of subsidies and subsidy reform are fraught encourages increased consumption of food, pos- with conflicting positions and diverse interests sibly due to changes in the share of resources involving international agencies, local communi- controlled by women. ties, ministries of agriculture (which represent farmers' interests), ministries of food (which rep- Challenges resent consumers' interests), and finally min- The main challenge for a successful subsidy pro- istries of finance (which are in charge of the gram is to select the right type of commodity that national budget). will not create distortions in the market and that will provide additional benefits to the intended The nature and timing of subsidy reforms consumers. depend on many factors, including the interplay of diverse interests expressed by local groups and There are also administrative challenges to con- international agencies. Balancing the different sider. Many subsidy programs require at least one interests is not easy, but country experiences distribution network, and some systems may suggest that the public is more likely to accept a require two: one for any coupons or ration certifi- policy change if: a) they are told the rationale cation and one for the commodities themselves. behind it in advance; b) credible policies and The costs of these systems may be appreciably safety net programs are introduced when the higher than the costs of private marketing. inefficient program is reformed; c) coalitions of public support offset opposition from interest As well, appropriate control systems are needed groups who benefit from the subsidies to be to limit the sale of subsidized commodities in the abolished; and d) targeted programs or income higher priced general market through `back-door' transfers are introduced when international sales. To help control subsidy programs, technol- prices rise. The World Bank Social Safety Nets Primer series is intended to provide a practical resource for those engaged in the design and implementation of safety net programs around the world. Readers will find information on good practices for a variety of types of interventions, country con- texts, themes and target groups, as well as current thinking on the role of social safety nets in the broader development agenda. World Bank, Human Development Network Social Protection, Social Safety Nets http://www.worldbank.org/safetynets Printed on 100% post-consumer recycled paper