Off target in subsidy reform
This week the bill to target subsidies, intended mainly to reduce subsidies for energy products, left Iran’s parliament (majlis) for the Guardian Council. The Council has the last word on matters legislative, and may well decide to kill the bill because the government does not want to implement it with the modifications added by the parliament. President Ahmadinejad, known more for its populist inclinations than pro-market sentiments, has taken an unlikely position to reform Iran’s $60 billion subsidy program (more than 15% of national income) on energy, food, and a few other items. But the dispute over who should control the revenues saved from the bill’s implementation (the subsidy fund, for short) threatens to derail this historic effort to wean Iranians off cheap energy. If the bill survives the Guardian Council, it is sure to die in implementation. Raising prices for basic commodities in the highly charged post-election political atmosphere of Iran is difficult enough, an unwillingness government is not likely to forge ahead with doing so.
At stake is control over as much as $20 billion per year of new revenues from the targeting program (see my previous post). It has divided President Ahmadinejad’s adminstration from even his the conservative-dominated parliament, which decided it would subject the expenditures out of the subsidy fund to the same rules as for other government expenditures. But a strong reason why the populist president would even want to engage in subsidy reform is being able to redistribute the proceeds. Why would Ahmadinejad take the political risks of an unpopular program if he cannot use the funds as he likes to? From the beginning, his adminstration has tried to evade restrictions on expenditures that he believes prevent him from reaching redistributive goals. That is exactly why he abolished the Management and Planning Organization in December 2006, and why he would like to have as little majlis oversight over the subsidy fund.
The bill is entitled “targeting subsidies”, but it removes subsidies for everyone. The targeting comes separately as cash payments to those below the median income irrespective of how much energy they use. Real targeting would price discriminate, selling cheap only to poorer consumers. It is the cash payments feature that is redistributive, taking money from energy users those above the median income to pay everyone below the median. The bill is thus a combination of what is often seen as a pro-market reform (see this recent article from a popular Persian website) and redistribution. This redistribution is not populist in nature, though it may appear as such, because it is simply redirecting public funds that now subsidise the rich and the middle class to the poorer half of the population.
The fear by many inside and outside the parliament is that the subsidy fund may be directed to serve the government’s political needs rather than the needy. So the parliament decided to subject expenditures of revenues from selling energy products to domestic consumers to the same rules that govern spending revenues from selling them to foreign buyers. However, from the point of view of the government this is putting it in a politically precarious position, especially following the fallout from the disputed June election. Having the freedom to spend the money how and where it sees fit would give the government the courage to go forward with the largest redistribution scheme since the 1979 revolution. It makes sense to me that if the government is to bear the brunt of the criticism from increasing prices on energy products, it should have some discretion over the subsidy fund to use it effectively and in a timely manner to redress imbalance from rising prices. This may not be good fiscal practice, but it may be a necessary price to pay to get the process of subsidy reform underway.
How we got to this stage is not as important as how we move forward. If the chance to reform Iran’s subsidy program is lost now it may not return for many years. The threat of losing momentum for the reform or its total abandonment is real enough. The Guardian Council is a conservative establishment and it would not be breaking with tradition if it sided with the Ahmadinejad government and rejected the bill. Even if the bill were approved as is, its implementation would suffer. I am reminded of the Egyptian food riots of 1977, when the US pressured Hosni Mobarak to remove food subsidies, which he was resisting. There were rumours at the time that government agents were among those bashing phone booths in Cairo to make a point.
It has taken the better part of two decades since the end of the war with Iraq for the public debate inside Iran to reach the conclusion that selling energy products at a fraction of their cost to poor and rich alike is bad social policy and even worse economic policy. Cheap energy has ruined not only the air people in large cities breathe, it has also ruined their lifestyle. In what other country with a productive middle class can you find them during a weekday driving around in heavy traffic after 10 pm? In addition, the energy subsidies are also highly regressive. My calculations show that the Gini coefficient of inequality for fuel subsidies is about twice that of income in general, and more than half the gasoline subsidy goes to individuals in the top 10 percent of the income distribution, compared to 4 percent for the bottom decile. In comparison, the bread subsidy is actually slightly progressive, with more than 10% going to the poorest decile. Add to these observations that Iran’s inequality is higher than all other large Middle Eastern countries, such as Egypt and Turkey, using the subsidy reform to improve it may not be such a bad idea.
Two important questions face Iranian policy (and opinion) makers at this time: First, will an unwilling President Ahmadinejad press on with raising energy prices in the coming months and years if the initial attempt to do so proves politically costly? Second, if the chance to reform Iran’s subsidy program is lost now, how long would it be before we get this close to subsidy reform? My answer to the first question in ‘no’ and to the second ‘several years’. Considering how costly it is to the environment to carry on with cheap energy, and how important it is to improve the distribution of income by redirecting subsides, if there a middle ground between the level of discretion sought by the government and the level of control desired by the legislature, the chance to seize it should not be missed.