"Gradual, sequenced subsidy reform is more politically durable than shock removal"

"energy subsidies often follow a life cycle. They begin with noble goals, such as helping to smooth out price fluctuations to protect the poor, but evolve in ways that inflate their cost and make reform politically difficult. One pattern evident across each of these cases is that breaking that life cycle has required the creation of alternative mechanisms for delivering benefits to the poor— notably cash transfers. Policy makers have, in most cases, created these programs in response to pressures and opportunities unrelated to the problem of energy subsidy. But once in place, the opportunity to adopt much more efficient social policy has made other reforms, including energy-related reforms, possible. Chapter 7 explores these and other issues in more depth, such as the different progressive tax and transfer strategies available in different economy contexts and how new green and digital tax instruments could increase fiscal space. It also asks why subsidies remain such popular fiscal instruments and briefly considers the political economy of fiscal reform. Notes 1. For a primer, see Horton and El-Ganainy (2020). 2. This chapter builds on Fuchs, Sosa, and Wai- Poi (2021), and is being extended to a global review of CEQ studies (Sosa and Wai-Poi, forthcoming). It also adds significant new material on taxation, original to this chapter. 3. The CEQ approach was developed by the Commitment to Equity Institute (CEQ Institute) at Tulane University. For information on the methodology, implementation guide lines, applications, and software of the CEQ approach, see Lustig (2018). 4. See CEQ Institute (https://commitmento equity.org/datacenter/) for data from all CEQ Institute studies and many World Bank ones. OECD and additional World Bank data from individual country studies have been compiled for this report. The compiled database used in this chapter and in Sosa and Wai-Poi (forth coming) are being publicly released. 5. The global ASPIRE data indicate that active labor market policies represent a small share of spending compared with that on social assistance, social insurance, and pensions as of January 2022 (see World Bank, forthcoming). 6. OECD compiles fiscal incidence data from each member, usually estimated by the national statistical agency, and in all cases representing the official incidence data for that economy. In five economies there are both OECD and CEQ data: Chile, Croatia, Poland, Spain, and the United States. In each case OECD data are used, despite not including the indirect tax and subsidy results from the CEQ data set, because OECD data are based on official econ omy estimates and are more recent than CEQ data—fiscal years 2011 (United States), 2013 (Chile), 2014 (Poland), 2016 (Spain), and 2017 (Croatia). 7. Based on the World Bank’s country income and regional classifications (https://datahelpdesk​ .worldbank.org/knowledgebase/articles/906519​ -world-bank-country-and-lending-groups). 8. The tax and spending levels and compositions from these databases as discussed in this chap ter differ from the tax and spending compo nents included in individual CEQ economy studies, which do not include all taxes and spending. This chapter uses the more compre hensive databases for a discussion of levels and compositions of taxes and spending, and the CEQ data for a discussion of incidence. 9. See International Centre for Tax and Development (https://www.ictd.ac/dataset​ /grd/); World"

"spending, which will largely determine the net distributional impact of fiscal policy. In turn, economies need to consider not only the long-term returns on different spending (as chapter 6 explores) but also who benefits in the short term. Subsidies are generally expen sive, regressive, and distortionary; a transition away from subsidies to a broader and more targeted social safety net will likely reduce inequality and poverty but also create more fiscal space for needed investments to restart growth as economies try to recover from the shock of COVID-19. However, the need to finance an inclusive recovery in the face of limited fiscal space means the efficiency of redistributive spending beyond the use of subsidies also needs to be examined. For example, in 2015, Indonesia redirected substantial spending away from fuel subsidies to greater infrastructure investment and higher spending on health and social protection. Revisiting its social assistance spending mix, it moved away from subsidized food transfers that were costly but had relatively little redistributive impact. In addition, Indonesia massively expanded its conditional cash transfer program, which had the highest redistribu tive effect per dollar spent but little aggregate impact because of low budgets (see Indonesia, Ministry of Finance and World Bank 2015, 2020). It also invested significantly in improving its targeting of social assistance and the entire delivery chain over a number of years (Holmemo et al. 2020). This brief snapshot of Indonesia’s relative success in moving from heavy fuel subsidy spending to a more targeted but broad social assistance framework belies the complicated political econ omy of subsidy reform. Beaton, Lontoh, and Wai-Poi (2017) provide an in-depth review of six major subsidy reform attempts in Indonesia between 2000 and 2015, some successful and some not. In particular, they highlight the importance of coalition building, analysis and preparation, coordinated messaging, and timing and opportunism. Of particular relevance to the current chapter is the importance of social assistance in mitigating the impact of reforms over time and the virtuous circle that can take place between subsidy reforms and investments in social assistance capacity. As countries develop more sophisticated tools to assist businesses and households, it becomes easier for them to manage some of the negative impacts of higher energy prices through more effective, more-efficient policy tools. At the same time, subsidy reforms can liberate funding that allows for investments in social assistance capacity. Most of Indonesia’s fuel price increases have 182 POVERTY AND SHARED PROSPERITY 2022 been coupled with some form of support targeted at the needy, and as this support has improved over time, so too has the likelihood of successful price increases. (Beaton, Lontoh, and Wai-Poi 2017, 134) Inchauste and Victor (2017, 33–34) synthesize the experience of Indonesia as well as that of the Dominican Republic, Ghana, and Jordan, concluding that “the most successful reforms nearly always involve a large amount of political engineering” and that energy subsidies often follow a life cycle. They begin with noble goals, such as helping to smooth out price fluctuations to protect the poor, but evolve in ways that inflate their cost and make reform politically difficult. One pattern evident across each of these cases is that breaking that life cycle has required the creation of alternative mechanisms for delivering benefits to the poor— notably cash transfers. Policy makers have, in most cases, created these programs in response to pressures and opportunities unrelated to the problem of energy subsidy. But once in place, the opportunity to adopt much more efficient social policy has made other reforms, including energy-related reforms, possible. Chapter 7 explores these and other issues in more depth, such as the different progressive"