In spite of opposition that saw the streets of Kuala Lumpur filled with pro-fuel subsidy groups during the Abdullah administration, efforts to liberalize the fuel subsidy regime have gone a long way. Several arguments, including one that criticizes the untargeted and blanket nature of the policy have gained tremendous traction. The fact that it benefits those who do not need or deserve the subsidy is clearly one of the main motivators — the bigger drivers are probably cost and waste — behind the reformation of the policy.
The Najib administration is addressing this particular criticism. That has resulted in multiple novel moves and proposals from the federal government. Among the proposals reported in the mainstream media are different prices for different groups, a cap on subsidized fuel consumption and access to subsidy based on engine size. All of it tries to discriminate consumers at the pump. While the moves and proposals may reduce the size of fuel subsidy either in value or in quantity, the proposals under explicit fuel subsidy regime are too convoluted. The more convoluted the methods are, the more complex the implementation will be. That is a recipe for a disaster, policy wise.
I appreciate the government’s effort at making the policy more targeted and hence, making it less wasteful in terms of opportunity cost. Yet, these novel ways are unnecessary given the existence of at least one simpler alternative.
Just observe the recent attempt to limit the sale of subsidized fuel to foreigners at the border. So complicated was it that everybody was confused and in the end, it did not work. Consumers found ways around the restriction.
There is a better and much simpler way to do to this.
Before we proceed to that better and simpler policy, it is crucial for us to recall the purpose of the fuel subsidy. Its goal is ultimately to reduce the cost of living of the less well-to-do Malaysians. On top of that, fuel subsidy is not the only way to achieve that goal.
With that in mind, the better alternative to targeted fuel subsidy is a simple targeted cash transfer from the government to those who deserve it.
Why targeted cash transfer?
The first reason is that it paves the way for total elimination of fuel subsidy to free up the market. Since free prices signal scarcity, individuals and entities will make decisions that are more reflective of the reality of the energy market. On top of that, it creates real competition among pump owners. The same system of free prices already exists in the United States and Australia. Its effectiveness is proven.
Not only that, elimination of subsidy at the pump reduces consumption, all else being constant. That means lower carbon emissions. In times when carbon emissions are a worldwide concern and in light of the Najib administration’s promise to announce a carbon cut roadmap in the near future, this is an opportunity to integrate transportation and energy policies together environmental policy. Such integration is important given that, according to the International Energy Agency in 2007, the transportation sector was the source of 30 per cent of Malaysia’s carbon dioxide emissions in 2005.
Thirdly, cash can be used for a variety of things and not just fuel. Maybe a beneficiary of such a cash transfer appreciates books or food more than fuel. This has the potential of increasing the beneficiary’s welfare higher than what a fuel subsidy policy can bring. If the beneficiary does appreciate fuel more than anything else, then he or she can simply buy the same amount of fuel he or she would have otherwise bought under the fuel subsidy policy. In other words, there are more choices. The economics behind cash transfer is clearly more welfare enhancing than a simple fuel subsidy.
The next question is, naturally, how to do it.
If the sale of subsidized fuel is to be limited, then the government will have a good idea about the maximum amount of money it needs to spend on fuel subsidy. Furthermore, the lower the cap, the higher the likelihood a beneficiary of the subsidy will exhaust his or her quota. From there on, certain statistical manipulations can give us the size of money transfer per capita required to make the cash transfer method the equivalent of the fuel subsidy policy in terms of value.
The cash transfer itself can be delivered to the deserving via the existing tax system. Here is another beauty of cash transfer. It pays only to those who have filed their taxes. Thus, this is yet another incentive for those who have yet to file their tax to finally do so.
For those who just want to fill up their vehicles, here is another reason to support a simple cash transfer instead of an explicit targeted fuel subsidy policy: no weird rule at the pump. With cash transfer, any discriminative method used to ensure that the policy is targeted is done not at the pump but during the transfer of cash. This makes its implementation simpler.
So, what about it that is not to like?
A version of this article was first published in The Malaysian Insider on January 19 2010. Unlike the TMI edition, I added several sentences and phrases here to emphasize or rather, to clarify that the cash transfer is targeted in a sense that whatever discriminative method introduced in a subsidy regime can be applied to cash transfer system.