Benefit Incidence of Fuel Subsidies in Madagascar and Recommendations for Child-Friendly Reallocation

Abstract

Fuel subsidies lead to environmental damage through inefficiencies in energy use, they are a burden for public budget and moreover they are regressive, benefiting the already better off households. Despite, these negative qualities, energy subsidies are still implemented throughout the World. Post-tax energy subsidies in the World are estimated to be 5.3 trillion USD while fuel subsidies alone, are estimated to be 1.5 trillion USD, making up 1.8 percent of the global GDP in 2015. Although fuel subsidies are regressive, fuel subsidy reforms impact the poor the hardest. Previous experience with fuel subsidy reforms around the World show that, poverty increases as a result of fuel subsidy removal if it is not mitigated with redistribution efforts like cash transfers.In Madagascar, the government decided to eliminate fuel subsidies gradually in June 2014. Yet, price control mechanism has not been dropped yet. Given the sharp fall in international oil prices in the last year, a window of opportunity has opened for Madagascar and countries alike to adopt a liberalized pricing system and abolish fuel subsidies.Using ENSOMD 2012 data set, we show that in Madagascar, fuel subsidies are highly regressive. Gasoline and diesel consumption is very rare in the households in the bottom 60 percent while kerosene is commonly consumed by households from all income groups. We find that poor households are affected the least if kerosene price remain unchanged. Nevertheless, different price increase scenarios including a change in the price of kerosene do not increase poverty by more than 1 percentage points. Instead reallocating the gains from the fuel subsidy reform to children aged 0-4 or 0-14 uniformly is found to decrease poverty rates between 2.4 to 4.6 percentage points.