Subsidizing the rich

Subsidizing the rich

Indonesian presidents after Soeharto are likely to have learned
one important lesson from the former dictator: Don't slip on the
oil. Politically, oil is indeed a slippery commodity for
Indonesia. Every president since Soeharto has had to think twice
before taking any decision to raise fuel prices, as every time a
government increases them, there is almost certainly going to be
a public backlash.

Megawati Soekarnoputri knew that well, and used oil to fire up
her reelection bid this year, by keeping domestic fuel prices
constant amid soaring international oil prices. Despite what was
arguably a highly irresponsible policy, there was no helping her
reelection bid, and now there is also a hefty burden on the new
government, in the form of Rp 45 trillion (US$6 billion) in extra
costs for the additional fuel subsidies for this year alone.

The current administration has no choice but to increase fuel
prices to reduce the subsidies. There are a number of reasons for
why reducing fuel subsidies is far more urgent now than ever
before. In the past, high crude oil prices used to be a good news
when the country was a net oil exporter. High prices meant a
windfall profit for the country. Now this situation has changed
and this year for the first time the country has become a net
importer of oil.

In the past, before Indonesia decentralized its finances, all
proceeds from oil and gas went to the national government,
however, now, the government has to share 15 percent of non-tax
revenues from oil and 30 percent from gas with the regions where
oil and gas resources are located. However, in terms of spending,
the central government bears all the costs for subsidizing the
fuel. For the government, maintaining fuel prices at the current
level is increasingly unsustainable -- according to Vice
President Jusuf Kalla it is burdening the state with costs of up
to Rp 10 trillion a month in subsidies, depending on
international oil prices.

Even if prices were not as bad as they are now and Indonesian
again became a net exporter of fuel, it is still not wise to keep
Indonesian fuel prices so low compared to those in the region. As
a comparison, gasoline that the Indonesian government retails at
about US 20 cents a liter, sells at 85 cents in Singapore and 53
cents in Thailand. Like all subsidies, this low-price policy is
subject to abuse.

As often reported, subsidies in Indonesia have frequently
failed to help their intended target: the poor. Many subsidies
end up benefiting the more affluent groups in society because of
their stronger political and purchasing power or simply because
of corruption.

Fuel subsidies are glaring examples of where subsidies end up
benefiting high-income groups although the original justification
for their existence was to assist the poor. Subsidies for auto
diesel and gasoline fuel mostly benefit car owners, whose incomes
are in the top 10 percent bracket of Indonesians. Even subsidies
for kerosene, a main cooking fuel, end up benefiting relatively
high-income groups most, as according to the World Bank report
Poverty Reduction in Indonesia: Constructing a New Strategy,
2001, the poor consumed only 20 percent of the subsidized
kerosene sold.

The other downside to fuel subsidies is the widespread fuel
smuggling to neighboring countries and the excessive domestic use
of fuels resulting in higher pollution. If domestic prices are
set at similar levels with those in the neighboring countries --
smuggling would stop and consumers would use fuel more
economically.

Worse still, the increasing burden of subsidies left unchecked
will eventually increase public debt, already at high levels. And
allowing public debt to increase will only eat into the
government's budget to finance programs for the poor.

It is clear now that fuel subsidies cannot be justified on any
grounds, except politically. So, rather than subsidizing the
rich, encouraging smuggling, creating pollution, and building up
public debt as a result of fuel subsidies, why not abolish such
subsidies altogether. However, cutting subsidies is not an easy
task as they benefit groups that often have political clout.

What the government needs to consider now is how to chose the
timing of the subsidy reductions and prepare targeted
compensation programs for the poor, especially who are definitely
likely to suffer from an increased prices of fuel.

The government also needs to consult with Bank Indonesia about
how to implement the price increases in order to mitigate adverse
inflationary affects.

Most importantly, the government needs to put out a message
debunking the myth that fuel subsidies end up benefiting the
poor.