Why targeted fuel subsidies are better than fuel tax cuts

Russia’s invasion of Ukraine is now into its seventh week, and it is amid this backdrop of conflict and uncertainty that global oil price hikes have become starkly pronounced. The prices, nonetheless, had been rising much earlier than Russia’s invasion.

Since the price of Dubai Fateh crude fell to $33.75 per barrel in March 2020, oil prices have seen a dramatic increase. The price of crude had nearly doubled to $63.95 just one year later in March 2021, and has risen further still ($113.11 per barrel as of March 2022). Notably, this isn’t a historic high; crude prices had previously peaked at $131.22 per barrel in June 2008.

Why has the war in Ukraine had a big impact on oil prices? Russia is not a major oil supplier to the Philippines in particular, accounting for just 1-3% of the country’s volume of crude imports (before the pandemic). However, Russia does account for 10 to 11% of the world’s imports, supplying primarily to European markets. This is not an insignificant amount, and supply shocks on the Russian end will mean a greater global dependence on Organization of the Petroleum Exporting Countries (OPEC).

OPEC faces its own incentives. Given that oil prices fell dramatically during the height of the pandemic lockdowns, OPEC is likely keen to recoup the profits it had lost, now that economies are recovering and demand is rising.

The steep price hike has come at a politically complicated time as well — in the middle of a heated Presidential campaign. Expectedly, candidates have mostly echoed what they might perceive as the most popular (or populist) policy.

Isko Moreno Domagoso has declared that his policy will be to slash fuel and electricity prices by 50%. Both Senators Manny Pacquiao and Ping Lacson have called for a review of the fuel tax, if not an outright suspension. Both Bongbong Marcos and Leni Robredo had initially favored tax suspensions, but both have shifted towards emphasizing subsidies instead. However, Marcos prefers a fuel subsidy for “anybody who is using oil-related products which is basically everybody.” Vice-President Robredo has revealed a more nuanced four-point plan that includes subsidies that are more targeted to the public transport sector, including service contracting to replace the boundary system and pivoting toward more sustainable and efficient transport alternatives.

While a fuel tax cut may seem appealing for its simpleness, we must consider its implications and assess its costs and benefits. Proponents of reducing fuel prices at the pump might argue its benefits for everyone. But because it is a blanket policy, it doesn’t truly benefit everyone. According to the 2015 FIES, the richest 10% of Filipino households account for 51% of the total fuel consumption in the country. The richest one percent alone account for 13% of total fuel consumption. Fuel consumption is heavily skewed towards the most well-off Filipino households, and so a blanket tax cut will disproportionately benefit them. That means losing revenues from the oil consumption of the rich or upper classes, which in turn would cut public spending for the poor and working classes.

Cutting the fuel tax for everyone is thus highly inequitable, not to mention the opportunity cost it causes.

Earlier, the Department of Finance (DoF) estimated that suspending the fuel tax would result in forgone revenue equivalent to P105.9 billion. This forgone revenue may even go as high as P147.1 billion if prices continue to rise.

As the economy is transitioning to full recovery amid uncertainty and a high government deficit, fiscal policy must protect revenues to finance essential public goods, including those related to contingencies. Hence, instead of a universal subsidy or a suspension of fuel taxes that benefits mainly the upper classes, a targeted approach of providing relief to the more vulnerable sectors such as lower income families, commuters, and farmers is much more efficient and equitable.

The DoF estimates that the VAT alone on fuel can fund an annual cash transfer of P2,400 for the bottom 50% of Filipino households totaling P33.1 billion. Collected revenue can also be utilized to fund the transport reforms that Vice-President Robredo has proposed.

The leakage or inequitable distribution of subsidies is truly a problem. During the pandemic, many local government units did not have proper targeting mechanisms, and the result was that even rich households living in gated communities received ayuda.

Given the fiscal constraints, we must be more strategic in our targeting. The problem is solvable. The roll-out of the Philippine Identification System, already nearing completion, can significantly minimize the leakage. Positive and negative lessons from the cash transfers that accompanied TRAIN (Tax Reform for Acceleration and Inclusion) which included the increase in excise fuel taxes, and the social amelioration program in response to the pandemic will inform the implementation of targeted subsidy.

In this light, the DoF approach of having targeted subsidies to benefit the lower-income groups while safeguarding the fiscal space, which intersects with VP Leni’s nuanced platform, is the way to go.

AJ Montesa heads the policy research team of Action for Economic Reforms.