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Who benefits from utility subsidies?

Caroline van den BergK. Komives, V. Foster, J. Halpern, Q. Wodon and R. Abdullah

September 13, 2006

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Consumer utility subsidies widespread

Most residential customers are not charged the full cost of the water and electricity service they receiveAverage residential tariffs only cover O&M plus some capital costs in:– 3% of water utilities in low-income countries– 39% of water utilities in upper middle income countries– 50% of water utilities in high income countries

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Why are these subsidies a concern?

Subsidies can be justifiedConcern about…– Impact of “unfunded” subsidies on customers – Effect of subsidies on incentives

• Inefficient water consumption• Disincentives on utilities to reduce costs, expand service

– Do subsidies really reach the poor?• Some case study evidence suggested problems

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Assumptions behind subsidizationA policy of subsidizing basic services is conceptually appealing…– Cost recovery prices are not considered “affordable”– Subsidies are assumed to help guarantee service for all– In-kind transfers are seen as easy to implement

And… these services also lend themselves to subsidization…– High fixed costs with long asset lives

• Possible to get away with under-pricing in the short term– High percentage of non-attributable costs

• Hard to assign costs to particular customers– Monopoly services

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How did we answer these questions?

Systematic comparison of case studies– Existing and simulated subsidies– From 13 water utilities and 27 electrical utilities from Asia, Latin

America, Africa, and E.E./C.A.

Estimation of the financial value of the subsidy: – Avg. cost of water or electricity received – amount paid

Determinants of targeting performance– Benefit targeting indicator (% of benefits going to poor / % of pop that is

poor): <1.00 regressive; > 1.00 progressive– Access and uptake rates, targeting, subsidy per unit, quantity consumed

and cost

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Who benefits from utility subsidies?

Beneficiary targeting: Do subsidies reach the poor?Benefit targeting: What percentage of the benefits go to the poor?

Why care about targeting?– Lower subsidy budget – More bang for the buck– Fewer distortions in consumption decisions

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Beneficiary targeting

The evidence about subsidies reaching the poor

0%

20%

40%

60%

80%

100%

Poorest 2nd 3rd 4th Richest

Access to WSS by income quintile

Water supply Sanitation

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Benefit targeting:Existing quantity based subsidies regressive

% of poor hhs receiving subsidy vs. benefit targeting performance

India, State IBTs, 0.56

Cape Verde, 0.48Sao Tome, 0.41

P eru, 0.82Honduras, 0.49

Guatemala, 0.20

Hungary (S), 0.98

Rwanda (S), 0.35

Kathmandu, 0.56

Bangalore, 0.66Sri Lanka, 0.83

Cape Verde, 0.240.0%

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20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

0.00 0.20 0.40 0.60 0.80 1.00 1.20

Benefit targeting performance indicator

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Access, connection, and metering– Many poor households are

simply not eligible

Quantity-consumed is not necessarily a good indicator of poor households

Water consumption by quintile

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Why?

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Why? (2)

Most existing subsidies are general subsidies to all or almost all residential customers– Few households pay average cost or cross-subsidize others

Quantity-targeted subsidies usually provide a greater subsidy per unit to low volume consumers, but… – A smaller subsidy over more units of consumption = a larger total subsidy– If there is a fixed fee, the smallest volume users pay the highest average price

per unit

Can quantity-targeted subsidies be improved by tinkering with the tariff structure?– E.g. reducing the size of the subsidized block of an IBT

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Can the targeting of quantity-based subsidies be improved?

Tinkering with the tariff won’t help households without access, connections, or meters

Two changes could help marginally improve targeting performance:– Very small first block of an IBT– Moving from an IBT to a “volume-differentiated tariff”

But only if – (1) poor consume significantly less than the non-poor, and – (2) average residential tariffs are at or near average cost

Improvement would be easiest for utilities with a high degree of cost recovery, located in areas with high coverage of connections and meters

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Other alternative forms of subsidies

Service-level targeting of consumption subsidies– Self-selection: are the poor more likely than non-poor to choose a

lower service level?• Subsidies for public water taps

– Bangalore Ω = 2.14; Kathmandu Ω = 1.54

Are connection subsidies doing better?– Benefit goes beyond the cost of the connection itself– Simulations results are all progressive

• But will the poor be offered connections? And will they connect?• How large is the group of consumers that are poor and not connected?

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Other alternative forms of subsidiesGeographical targeting

– Pro: better targeting than quantity based subsidies– Cons:

• Can work if poor and non-poor live in different areas• Many customers must pay the cost for geographical targeting

Means testing targeting– Pro: better targeting than previous types– Cons:

• High administrative cost• High errors of exclusion

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Subsidies as social transfers

Consumption(Quantity)

Geographic Means-testing Self-selection(Service level)

Water

Existing Cons 0.60 1.05 1.36 1.84Sim. Cons 0.78 0.86 1.19 -

Sim. Conn - 1.30 1.71 -

Electricity

Existing Cons 0.63 0.90 1.23 -

Sim. Cons 0.64 - 1.39 -

Other* 1.00 1.33 1.40 1.78

Median targeting performance, by type of subsidy and targeting method

*From Coady et al study on targeting performance of social transfers

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Parting thoughts:Subsidies as “pro-poor” utility policy

Keeping services affordable for the poor?– Only for the connected poor (with meters), who are

accurately identified by the targeting mechanism

What about low coverage situations?– Connection subsidies are often more likely to reach the

poor, but…• There may be other barriers to connections (tenure status, cost of

fixtures, billing practices, good alternatives)• Connecting more households to a service burdened by

“unfunded” subsidies will only further erode bankrupt utilities

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Parting thoughts:Subsidies as “pro-poor” utility policy

Our assumptions on the poor and their demand for WSS services are not always very accurate:– Whether subsidies are needed is based on assumptions of

demand and knowledge on household behavior on utility level

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Parting thoughts:Prices, subsidies, and cost recovery

There is no easy way around the need to increase levels of cost recovery if service is to be improved and expanded.– The removal of existing regressive subsidies is widely unpopular.– Improving the targeting of subsidies won’t change that.

But raising prices or securing alternative sources of subsidies are not the only possible tools:– Improving revenue collection– Reducing operating and especially capital costs – Removing impediments to more flexible service levels, technologies,

and modes of provision