Fuel Subsidy Reform and Green Taxes: Using Digital Technology to Do It the Right Way

Countries do not find it easy to reform fossil fuel subsidies. On New Year’s Day in 2012, Nigeria’s president, Goodluck Jonathan, abruptly eliminated all gasoline subsidies to contain the country’s fiscal crisis, more than doubling the price of gasoline overnight. After a week of “Occupy Nigeria” citizen protests that spread quickly through social media, the government was forced to reinstate the subsidies, further eroding its credibility in the eyes of the general public.

In Haiti, the government was more ingenuous, or so it thought. To comply with a fiscal adjustment plan agreed with the International Monetary Fund, it decided to increase fuel prices by 50 percent in July 2018, timing the announcement during the soccer World Cup quarterfinal match between Belgium and Brazil, the country’s adopted team. Brazil lost the match and violent protesters filled the streets, venting their anger with the move and organizing their protests through WhatsApp group messages.

The scenes in Port-Au-Prince were replicated in the streets of Paris a few months later, when the first Gillet Jaune (“Yellow Vest”) protests started. Two French provincial government employees launched a Facebook event urging people to block all roads on November 17 to protest the government’s decision to impose green taxes, thereby raising the price of petrol and diesel across the country. They are still continuing.

The difficulty with reforming fuel subsidies

Reforming inefficient and inequitable energy subsidies continues to be an important priority for policymakers, as does instituting “green taxes” to reduce carbon emissions. The IMF estimates that fossil fuel subsidies, defined as fuel consumption times the gap between existing and efficient prices (including environmental costs), reached $4.7 trillion in 2015, nearly 6.3 percent of global GDP. Underpricing the cost of local air pollution constitutes half of this amount, and accounting for climate change contributes another quarter of the total subsidy. The IMF estimates that efficient fossil fuel pricing in 2015 through the introduction of “green taxes,” for example, would have lowered global carbon emissions by 28 percent while increasing government revenues by 3.8 percent at the same time.

Given the urgency of reforming fuel subsidies, why is it so difficult to do so without political cost and popular protests, even with legitimate motives such as fiscal crisis, inefficiency, inequity, or climate change? In a new paper, we argue for a shift from price subsidies toward individualized compensation, with degree of targeting depending on country conditions. Digital technology, including for unique identification and payments, as well as general communications, can help build government capacity to undertake such reforms and build trust with the people as well.

A new approach to reform

Our review of four country cases (Bolivia, Nigeria, Iran, and India) points to three areas where policymakers can use digital technologies to make fuel subsidy reform happen.

First, governments need to control the narrative, raise awareness, proactively engage with citizens, and build coalitions of support (including through digital media), to mitigate the political risk of the reforms.

Second, the spread of digital technologies has made it possible to transition from general price subsidies to direct transfers or vouchers, which are more efficient and equitable. While relatively few countries have implemented this shift at scale, many have programs, such as social pensions, maternal and child benefits, student fee subsidies, etc., that are transferred digitally. These can serve as a backbone for direct payments of compensatory transfers to individuals.

Third, digital technologies can help to target beneficiaries in a progressive way, i.e. by making the wealthier ineligible for subsidies over time. Beneficiary lists based on unique digital IDs can eliminate duplicate and false entries and generate fiscal savings for the government in the process. Once lists are clean, the government can implement “soft targeting” through moral suasion (or “nudges”) encouraging recipients to self-select out of the subsidy, as in the “GiveItUp” program for cooking gas subsidy in India. In the next step, it can move towards “hard targeting” by requiring verification of income or asset ownership, removing those who fall above the means test. With better data on income and consumption, the targeting mechanism can exclude beneficiaries whose income is above a cut-off, or who own assets which indicate higher economic status, such as houses, or private motor vehicles, or are able to pay high fees for private schools. This graded approach is different from the one where the starting point is to reduce the number of beneficiaries, often in an arbitrary manner. Such a process can help mitigate popular opposition while at the same time consolidating wider support for the reforms, if they are perceived to be fair and equitable.

What about green taxes?

Will this mechanism work for green taxes? Our calculations indicate that for modest carbon tax rates, the levels of compensation may not be sufficient to warrant introducing a separate compensation program. It might be more feasible to graft additional financing onto existing programs, especially in countries where government transfers to citizens already form the core of their social protection. The compensation mechanism would allow countries to move towards efficient pricing for fuel. To offer some rough estimates, fossil fuels represent around 40 percent of total energy consumption for lower-income sub-Saharan Africa; green taxes of 20 cents per gallon would then amount to a cost increase of $14 per person per year. Applying this to Tanzania, it would come to around $70 per year for an average family. This is about the same as the level of compensation provided by the basic unconditional tranche of the TASAF PSSN social safety net program, although total transfers under this program can be considerably higher. A similar calculation for India suggests an average green tax cost increase of $12.50 per head. This would be modest relative to central budgetary spending on India’s large and complex system of social benefits and subsidies, which amounts to around $60 per person. Higher green taxes, say, equivalent to $1 per gallon, might warrant a standalone compensatory program.

Digital technology, including ID, payments, mobile communications, and social media, can offer governments a greater choice of instruments to carry out a subsidy reform program. The technology, however, is only a mechanism; it does not, in itself, create the political constituency and drive to push reform forward. The case studies in our paper show examples of what is possible, and what can be achieved with the right mix of policies and technology.