Efficient Subsidisation of Lpg: A Study of Possible Options in India Today (Based on a Report Commissioned by the Petroleum Federation of India)

Indian Institute of Management Working Paper No. 2006-04-07

61 Pages Posted: 9 Feb 2011

See all articles by Sebastian Morris

Sebastian Morris

Indian Institute of Management, Ahmedabad - Economics

Ajay Pandey

OP Jindal Global University - Jindal Global Law School (JGLS)

Date Written: April 1, 2005

Abstract

The budget contained an announcement that the central government would actively explore the option of using an appropriate form of the ‘food stamps’ or an alternative scheme to improve the efficacy and reduce the cost of the current system of administration of food subsidies. The announcement provides an opportunity to discuss the issues of subsidy on account of LPG and device a system of subsidisation based on ‘LPG Stamps’ or some other scheme to improve the efficacy of subsidisation and remove the large distortions created by the current system.

LPG subsidy has grown historically and has become quite high because of aggressive growth in connections and increase in per connection consumption in addition to rising input costs. Given that there is evidence that LPG subsidy has been ineffective in increasing penetration in rural and poorer households, there is a case for capping and targeting LPG subsidy. Otherwise it can explode over time unless new connection growth is curbed, which is indefensible.

The best option to curtail LPG subsidy would be to eliminate it straight away. However, there are at least two factors which are likely to make it difficult. Firstly, the input costs are high (from a historical point of view). Secondly, the high input prices coupled with lack of preparatory ground work may result in political mobilization against the move.

The next best option which sharply focuses on the deserving segment is direct subsidy to below poverty line families. These households may be given up to 8 coupons every year. Each coupon can be used for subsidy for a cylinder. A separation of the identification and issuance of coupon is critical to the success of this scheme. As clarified elsewhere in the study, by coupon we mean any technology which allows the target group to get a well-defined and secured entitlement. It could be paper coupons with security features or smart cards, using IT for identification and entitlements.

Direct subsidy to BPL family through coupon would allow them to pay cash equal to retail price less the subsidy per coupon. This amount and a coupon would entitle them to get a cylinder. The coupon surrendered to the dealer would be in turn be surrendered by him to the Oil companies, who would pay equivalent cash to the dealer. In fact, dealer may get an additional compensation for the cost of accounting and administration.

The BPL coupon holders may be allowed to trade the coupons as this would convert the LPG subsidy to income subsidy. Even if the transfer or trade is not allowed, it is bound to take place and the net effect of that would be sharing of subsidy between intended beneficiary and some intermediary.

Targeting LPG subsidy to BPL consumers may encounter problems in improper identification about which Oil companies need to work closely with district/ local administration so as to proactively eliminate inappropriately classified consumers.

Targeting BPL consumers for LPG subsidy also leaves open the possibility of non-BPL consumers taking connections in the name of BPL consumer and that of BPL consumers opting for multiple connections. Both problems are to some extent self limiting (due to conflict and due to connection charges) but warrant closer examination of new connections under BPL category.

Coupon based direct subsidies require efficient administrative support associated with coupon distribution, appropriate documentation, coupon accounting, collection and cash reconciliation. Coupons have to be difficult to copy and print to prevent frauds etc. This can be ensured by printing of coupons at a security press, or by suitable IT enabled mechanisms.

Irrespective of any method of LPG subsidy reduction, there is a need to examine the taxes built in currently estimated gross subsidy. The net subsidy to the consumers should be the basis of elimination otherwise the target is self-defeating (by being higher) and not justifiable (elimination of gross subsidy means moving from net subsidy to net tax regime).

Even if the state governments continue to collect sales tax, the central government which also collects taxes and simultaneously bears subsidy should neutralize the subsidy estimate from central taxes. The state governments need to be persuaded to retain the current amount of sales tax (but at a lower rate) otherwise states get higher revenue and the price target goes up.

In case the state governments were to pay truant on this issue, there is a need to explore whether differential issue prices can be used as a deterrent.

Another issue which warrants closer examination is the impact of volatility of input costs on retail prices. Had the industry been competitive, this would not have been a major issue. Clearly, some oversight or regulation is required so that prices are changed at appropriate intervals and are still neither excessive nor too low. It would be appropriate to set up a regulator to review periodically review the input costs and allow changes. He may allow prices on the basis of average cost with a lag or may prescribe a band linked to input costs and may monitor the prices to prevent any abuse.

The rationalisation of prices and of tax reform in this sector is long overdue. These need to be simultaneously pursued. It is possible for the entire sector to move towards a revenue neutral cenvat based tax regime. That in itself and the direct subsidization of kerosene and LPG through coupons is necessary to remove all the distortions. The ill effects of the distortions that result in misuse, diversion, revenue loss, and added environmental and governance problems can only be feasibility addressed by the movement away from price based subsidies to direct subsidies. Similarly kerosene subsidises if correctly targeted and administered can have large spillovers in the management of subsidies in LPG.

Keywords: Public-Policy, Subsidy, India, Oil, Kerosene, Pricing, Public-expenditure

JEL Classification: H5, H4, H24, O2, Q4

Suggested Citation

Morris, Sebastian and Pandey, Ajay, Efficient Subsidisation of Lpg: A Study of Possible Options in India Today (Based on a Report Commissioned by the Petroleum Federation of India) (April 1, 2005). Indian Institute of Management Working Paper No. 2006-04-07. Available at SSRN: https://ssrn.com/abstract=1756510 or http://dx.doi.org/10.2139/ssrn.1756510

Sebastian Morris (Contact Author)

Indian Institute of Management, Ahmedabad - Economics ( email )

Vastrapur
Ahmedabad 380015, Gujarat
India
+917966324805 (Phone)

HOME PAGE: http://faculty.iima.ac.in/~morris/

Ajay Pandey

OP Jindal Global University - Jindal Global Law School (JGLS) ( email )

Jindal Centre 12 Bhi12 Bhikaiji Cama Place
Near Jagdishpur Village
New Delhi, Uttar Pradesh/Haryana 110 066
India

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