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.